Market behavior and hurricanes

We are in the height of hurricane season and weather uncertainty is driving the natural gas market. Natural gas price have bounced significantly since the last hurricane in spite of the large and growing inventories in natural gas and the relatively mild weather as measured by cooling degree days. This is to some degree a recurring price behavior pattern in natural gas.

There is an increase in the market risk premium when storms form under the assumption that there will be a disruption in the natural gas market. The uncertainty is resolved when the storm passes and the risk premium is therefore reduced. The size of the risk premium will be a function of the hurricane path and intensity. Because it takes time for the hurricane to develop and for its path to be known, there is also time for the risk premium to grow and change with the features of the storm. While not smooth, the premium will develop over time.

The storm premium is not dissimilar to other economic announcement effects. We have survey or expectation information which can be discounted by the market as we approach an announcement date, but price jumps will be related to the unanticipated portion of an event. Surprises cause jumps. A close look at option premium shows that implied vol usually increase around a major announcement and then recedes after the economic announcement is made.

This risk premium price pattern should not be surprising. However, what is surprising is the size of the current swing. While it is hard to measure what is normal as a natural gas risk premium, the current change is a reaction to the fact that the last hurricane which hit Central America moved from a tropical storm to category 5 in a surprisingly short period of time. The warning time of the intensity was significantly shortened. The market is recalibrating its risk premium based on the information that the tracking time may be shorter for some hurricanes. Do not forget that we have just hit the peak of the season. There are still a number of major storms expected.