11-06-08 Natural gas buying advisor Energy Solutions said consumers should prepare for a sustained period of higher prices as "speculative greed" has surpassed basic supply/demand fundamentals as a primary market driver.
"Natural gas supply and demand is not out of balance, but that has taken a back seat to new money finding its way into commodities through index funds," the Verona, Wisconsin-based consultant said in a report. "This 'new' money, not underlying fundamentals of supply and demand, is the primary culprit for the recent price rise in natural gas."

Energy Solutions said that buyers as well as sellers are now hoping for higher gas prices as speculators have broken off into two classes -- the traditional speculator and the index speculator.
Index speculators, the firm explained, use commodity index funds such as the Standard & Poor's GSCI or the Dow Jones-AIG Commodity Index as a means of long-term investment. Index funds represent a composite price of various commodities, and when corresponding commodity prices rise, the index rises in turn. Those who invest in commodity index funds are always considered buyers, regardless of market conditions.

Unlike speculators in the futures market, index speculators are not required to liquidate their positions upon contract expiration, as they can roll their length into the in July. Moreover, they have no sensitivity to shifts in underlying commodity prices, Energy Solutions explained.
"Those that have invested in commodity index funds are seeing large returns and are happy," the firm said. "The large returns are due to climbing commodity prices, and the large returns attract more money as investors continue to pull money out of the stock market and direct it toward commodity index funds."

The "buy-and-hold mentality" of index speculators creates artificial demand in traditional commodity markets in turn, Energy Solutions said.
The consultant said consumers need to realize that index speculators are driving both gas and crude oil prices "much higher than anyone imagined." And buyers can no longer wait for government intervention, despite legislative calls to tighten controls over index speculators, Energy Solutions said.

The firm said high prices will ultimately lead to significant demand destruction, diminishing hedging needs and demand for futures contracts.
"As money tightens, media reports of declining demand will increase," Energy Solutions said. "At this point, index speculators will start facing some tough decisions about the numerous 'long' positions they have taken for 2008 alone."