Ukraine is strategic to Russia’s energy distribution

Last January, Nymex Natural Gas futures reached a 2 year high as the intensity of the Kiev protests escalated toward violence.  It is no secret that a number of strategic Russian energy pipelines run through Ukraine (see map), but how could political events in Ukraine impact US markets?

We compared key events in Ukraine with the trading volumes of CME’s Henry Hub Natural Gas futures contracts.   Above-average volumes combined with higher prices can be an indication of sustained demand.  As shown in the chart below, volumes across all contract months increased significantly upon each escalating stage of the Ukrainian crisis…

Political crisis in Ukraine & US Natural Gas Futures – 3 day average trading volumes by contract month

From the first Russian threats in October 2013 until February 28 there have been 4 distinct volume spikes, all correlating to significant news out of Ukraine.  The most chaotic spikes occurred on January 22 as the western world woke up to learn of the killing of three protesters in Kiev – a catalyst for nearly a 4-fold increase in trading volumes from last October.

On January 22nd, as news broke of the protester deaths, Nymex Nat Gas daily volumes increased to 18,500 (Feb contract).  On this day, the average bid-ask spread not only widened while the spread variance fluctuated (see research from Nanex) as news was absorbed, uncertainty took hold, and large orders flowed into the market (Early in the morning of January 23rd, in what appears to be a price discovery expedition, algorithms continued to raise the Bid prices of futures several ticks at a time, while Ask prices reluctantly followed suit.)

Natural gas futures volumes reached a pinnacle on January 28, with traders exchanging over 250,000 contracts in a single day (March contract) – on this day, the Ukrainian Government resigned, perhaps giving markets a sign that the situation had stabilized.

As to whether these higher volumes mean further upside to natural gas futures is uncertain.  The sheer number of contracts traded combined with these bid/ask shenanigans lead us to believe that a large number of buyers were putting in bids at a premium, possibly at or above the bid price. Whether this represents large short covering, or net-new buyers remains a mystery for now, but in the short term it would appear further upside may be in store.

Natural Gas accounts for nearly 25% the world’s energy supply, the demand for which has been outpacing crude oil.

US Natural Gas Exports

In Asia, buyers pay about $18 per mmBtu.  In the US market, that price is closer to $4.50.  With such a large price difference it’s not difficult to imagine the arbitrage opportunities.  However, vast infrastructure is required to move this unstable resource across continental lines, and so prices are set in a disparate array of global markets close to supplying producers.

Not to let $billions in trade go to waste, efforts have been underway to close that gap through exports (see chart{.broken_link}).

As a result, any threats to natural gas supply, such as what we are currently witnessing in Ukraine, can also felt in the US.  Should regions such as Asia wish to secure their natural gas supplies in the face of a crisis, this would certainly cause the volume and price spikes we have seen on Nymex natural gas contracts in recent weeks.