Natural gas markets entered January 2014 with low storage levels, following heavy withdrawals at the end of 2013. In January 2014, Lower 48 working inventories fell to a 10-year low, as freezing temperatures led to record natural gas demand and storage withdrawals. Significant inventory drawdowns continued into February 2014, further tightening the balance between natural gas supply and demand and leading to increased natural gas spot price volatility, before relatively less severe temperatures in March brought spot price volatility back to prewinter levels.
The Henry Hub natural gas spot price spiked on many days in January and February. As the winter progressed, increased spot price volatility led to increased interest in monthly delivery contracts, which provide a measure of protection against daily price fluctuations. This was particularly the case during the final three days of trading (bidweek) for the February 2014 Henry Hub natural gas delivery contract on the New York Mercantile Exchange (Nymex), from January 27 to January 29. During these three days, the February contract averaged $5.15 per million British thermal units (MMBtu). This was 74 cents/MMBtu higher than the average bidweek price for the January 2014 delivery contract, the largest increase between the January and February contracts since 2007. However, continued cold weather pushed the average spot price in February to $5.91/MMBtu. This was the largest difference between an average monthly spot price and the bidweek price for that month's delivery contract since December 2009, indicating that futures markets did not fully anticipate February's high prices.
Markets continued to factor cold temperatures and a tightening supply-demand balance into price expectations for the March 2013 futures contract. The March contract traded at more than $6.00/MMBtu from February 19 to February 21, before dropping to $4.86/MMBtu when it settled on February 26. As cold weather moderated at the end of February, demand for firm gas delivery in March fell significantly.
Producers and consumers also sought protection from price swings this winter through option contracts. Option contracts can serve as price protection by giving the buyer the right, but not the obligation, to buy (call option) or sell (put option) the underlying Henry Hub monthly delivery contract at a specified price. As with the futures market, activity in options markets increased in January and February, and then waned as cold weather moderated in March.
One useful instrument for gauging market uncertainty is implied volatility, a measure of the expected price variation of a financial instrument. In this case, the implied volatility measures the magnitude of expected price variations in the front-month futures contract. It is derived from the prices of call and put option contracts. As cold weather and depleted inventories increased price uncertainty, implied volatility hit its winter peak in late February. It then fell by more than two-thirds through this month as demand moderated with less severely cold temperatures.