Natural gas, the second-most actively traded energy futures contract in the world, isn't that much different than most things when it comes to pricing.

Demand and supply are the two main factors that dictate the direction of natural gas prices.

Weather is an important part of natural gas demand. When temperatures spend more time at the extremes than usual (very hot and very cold), natural gas consumption picks up through increased demand for heat and air-conditioning.

Supply, of course, is dependent on production. Given that most of us have heard the word "shale" at some point in recent years, it shouldn't come as much of a surprise to hear that natural gas production has been rising in the last decade alongside advanced fracking technology.

At this point last year, natural gas supplies (inventories) were hovering near record highs. I'll give you one guess as to where the price of natural gas was trading at that time.

If you answered "historically low," then give yourself a pat on the back. Natural gas prices in the first quarter of 2016 hit 17-year lows when they touched $1.64 per million British Thermal Units in March of 2016.

Fast forward to 2017, and natural gas inventories are nearly 17% lower than they were a year ago. If you’re now thinking that the price of natural gas has likely increased as supply went down, then you are right once again.

Over the course of the last year, natural gas has staged an impressive rally and now sits well above $3.00 per million British Thermal Units (getting as high as $3.30 in April 2017).

Last year, tastytrade's resident futures expert Pete Mulmat predicted that historically high inventories, combined with historically low prices, would put pressure on producers to lower output. Over time, his belief was that decreased production would eventually translate to reduced inventories, consequently pushing prices higher.

Pete nailed that prediction, as that precise scenario has indeed come to pass.

Whether you traded natural gas in the last year or not, there may be further opportunities in this much-followed commodity again at some point in the near future.

A cooler than expected spring in the United States has pushed up demand for heat in the short-term, which may be helping to sustain the rally in natural gas prices since last year. However, another important factor to note is that natural gas exports have been picking up over the last couple months.

Recently, the Chinese government announced they would reduce dependence on coal usage in favor of natural gas in the country's capital, Beijing. Well-circulated reports of frequent smog warnings in some of China's largest cities over the last several years could be the reason for this change. The Japanese have also indicated their desire to ramp up reliance on natural gas after the big scare at the Fukushima nuclear reactor.

While these developments may not be playing a direct role in rising natural gas exports from the USA at this precise moment, there's a good chance that demand from international consumers could at some point boost exports well beyond what's been seen historically.

The one things that is certain is that over the next several months, demand and supply will play a critical role in dictating whether natural gas prices rally even further, or experience a corrective sell-off.

On the demand side, hotter than normal weather this summer could help extend the rally. Additionally, traders should continue to monitor natural gas exports. If those continue to rise, then the uptrend in natural gas may extend much longer than the rally observed from 2016 to 2017.

Lastly, natural gas inventory numbers will continue to be an important data point. Just like crude oil, if storage levels get drawn down, that can be bullish for the underlying commodity (and vice versa).

Keep your eye out for new tastytrade programming related to natural gas. Futures Measures and Closing the Gap - Futures Edition are two shows that often touch on the subject.

If you have any questions about trading natural gas, or any other commodity, we hope you'll leave a comment below or email us directly at support@tastytrade.com.

Happy trading!


Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.