How does seasonality in natural gas create predictable patterns in the futures curve, and what risks does this create for hedgers?

Question

AcadiFi · Accepted Answer

Natural gas is one of the most seasonal commodity markets because heating demand in winter and air conditioning demand in summer create predictable consumption cycles, while production is relatively steady year-round.

**The Seasonal Cycle**

| Period | Activity | Inventory Effect | Futures Price |
|---|---|---|---|
| April - October | Injection season | Inventories build | Lower (summer shoulder) |
| November - March | Withdrawal season | Inventories draw | Higher (winter premium) |

The futures curve typically shows **winter premiums** of $0.50 - $2.00/MMBtu above summer months, reflecting the cost of storing gas from summer injections through to winter withdrawals.

**Storage Economics**

The spread between a winter futures contract and the preceding summer contract must cover:

**Winter - Summer >= Storage Cost + Financing Cost + Injection/Withdrawal Fees**

If the spread exceeds total carry costs, storage operators inject gas in summer and sell winter futures to lock in a profit. This arbitrage keeps the seasonal spread bounded.

**Worked Example**

Ridgeway Energy is evaluating whether to inject gas into its Appalachian salt cavern facility.

- July Henry Hub spot: $2.15/MMBtu
- January futures: $3.40/MMBtu
- Calendar spread: $1.25/MMBtu
- Storage rental: $0.42/MMBtu
- Injection + withdrawal fees: $0.18/MMBtu
- Financing (6 months at 5.2%): $2.15 x 0.052 x 0.5 = $0.056/MMBtu

Total carry: $0.42 + $0.18 + $0.056 = **$0.656/MMBtu**

Net margin: $1.25 - $0.656 = **$0.594/MMBtu** -- profitable, so Ridgeway should inject.

```mermaid
flowchart LR
    A["Summer: Buy gas at $2.15"] --> B["Inject into storage"]
    B --> C["Sell Jan futures at $3.40"]
    C --> D["Winter: Withdraw & deliver"]
    D --> E["Lock in $0.594/MMBtu margin"]
```

**Risks for Hedgers**

1. **Basis risk** — Local hub prices may diverge from Henry Hub
2. **Volume risk** — Weather-driven demand may differ from hedged volumes
3. **Operational risk** — Cavern capacity constraints, force majeure events
4. **Regulatory risk** — FERC pipeline scheduling changes can strand gas

**Exam Note:** FRM questions often test whether a given seasonal spread is sufficient to cover storage costs, or ask you to identify which months have the highest convenience yield (typically late January/February when cold snaps threaten inventories).

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How does seasonality in natural gas create predictable patterns in the futures curve, and what risks does this create for hedgers?

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