Analysis of Rallies 02-24-08 - Energy Solutions

Natural gas prices on the New York Mercantile Exchange (NYMEX) have been in rally mode since early January and natural gas prices have reached new heights. While colder weather in parts of the nation has provided some support for natural gas prices, strength of natural gas prices on the NYMEX has also been caused by technical short-covering and soaring crude oil prices. No one has a crystal ball that can deter-mine exactly when this current rally will end, but history may provide some guidance. For that reason, Energy Solutions, Inc. has completed the attached analysis on historical natural gas price rallies. We are pleased to share our findings with you, but want to emphasize that our findings represent our opinion only and cannot be guaranteed.

Table of Contents

Introduction ........................................................................................................................................ 2 Review of the Current Price Rally ................................................................................................. 3 The Transition to a Technically-Driven Rally ............................................................................... 4 Determining Price Resistance Levels ............................................................................................. 7 Historical Rally Price Behavior vs. the Current Rally ................................................................. 8 Duration of Historical Rallies ...................................................................................................... 8 Post-Peak Price Action .................................................................................................................. 9 Conclusions of the Current Rally .................................................................................................10 Attachment A: Graph of Physical Spot Market Prices vs. Front-Month NYMEX .............12 Attachment B: Graph of Natural Gas Storage Inventories ....................................................13 Attachment C: Graph of Historical Price Rallies That Exceeded $8 per MMBtu .............14 Attachment D: In-Depth Analysis of Price Rallies That Exceeded $8 per MMBtu ...........15

Analysis of Historical Natural Gas Price Rallies

Published: March 3, 2008

Disclaimer: The information contained herein is the opinion of Energy Solutions, Inc. The information, views and opinions contained herein are presented for the convenience of the reader and are provided on the condition that errors or omissions therein, or reliance thereon, shall not be made the basis of a claim, demand or cause of action. The views and opinions expressed herein are for informational pur-poses only, are in no way guaranteed, are expressed as of a specific time and are subject to change at any time without notice.

Introduction

This analysis was prepared on March 3, 2008, and therefore does not evaluate any price moves since that date. The purpose of this analysis is to evaluate historical natural gas price rallies and to look for similarities between past ral-lies and the current natural gas price rally that started on the first day of 2008. Natural gas price rallies can impact physical spot market prices and natural gas futures contract prices on the New York Mercantile Exchange (NYMEX).

• The physical spot market or cash market represents the price of natural gas where the actual physical product or commodity is traded or delivered. We often refer to the physical spot market as being something similar to a gas station where you fill up your car with gasoline because each day the price of unleaded gasoline changes, and the price may vary from city to city and state to state.

• The NYMEX is a commodity exchange based in New York City where natural gas futures contracts are traded. Each futures contract relates to a specific month and is equal to 10,000 MMBtus. The NYMEX exchange as-signs a value to the cost of natural gas in monthly increments for the current year plus the next 12 years through December, which at this time is December 2020. Unlike the physical spot market, the value of a natural gas NY-MEX futures contract reflects delivery to a single geographic location, the Henry Hub, which is located off the Sabine Pipeline in Louisiana. As physical market conditions change, the value of natural gas NYMEX futures contracts change. The term front-month natural gas NYMEX contract refers to the most current monthly con-tract being traded. Each futures contract expires three business days prior to the first of the month. The March 2008 natural gas NYMEX contract expired on Wednesday, February 27, 2008, at $8.93 per MMBtu — the third highest expiration ever for a monthly NYMEX contract if you don’t include price impacts from the catastrophic 2005 hurricane season. With the expiration of the March 2008 natural gas NYMEX contract, the April 2008 natural gas NYMEX contract became the front-month natural gas NYMEX contract effective Thursday, Febru-ary 28, 2008. The monthly expiration price of a NYMEX contract is very important as it can be the benchmark of how natural gas will be priced for the upcoming month. Utilities, natural gas marketers, and producers widely use the expiration price as a buying and selling reference point. Thus, price activity of natural gas NYMEX con-tracts very often impacts the price that one pays for natural gas.

For the majority of this analysis the focus is on what happens to prices on the NYMEX during a rally, but for pur-poses of comparison, we’ve included a graph (Attachment A) that illustrates how the physical spot market (cash prices) in two areas, Chicago and southern California, have recently compared to the daily settlement price of the front-month natural gas NYMEX contract. The daily settlement price is the price established by the NYMEX Ex-change Settlement Committee at the close of each trading session. On Attachment A, you’ll note that while these physical delivery points are higher or lower than the settlement price of the front-month natural gas NYMEX con-tract, overall there is a trend between physical spot market natural gas prices and the value of natural gas futures con-tracts being traded on the NYMEX. This trend would likely be similar for other geographic locations as well. In today’s market, the ability to trade natural gas futures contracts is available nearly 24 hours a day with a 45-minute break between 5:15 p.m. and 6:00 p.m. Eastern Standard Time (EST). Trading during Monday through Friday can take place from 9:00 a.m. to 2:30 p.m. in an open outcry format that requires a trader to be present on the NYMEX trading floor in New York. Trading can also take place electronically via the Chicago Mercantile Exchange (CME) Globex® trading platform, and any trading done on Globex® is referred to as electronic trading or overnight trading. Because of its convenience and wide availability, electronic trading continues to increase while at the same time trad-ing in the open outcry format where a physical individual must be present to trade is declining. If this trend contin-ues, it is very possible that the open outcry format, on which the NYMEX was built, will be discontinued and all trad-ing will be completed via electronic trading.

March 3, 2008 Energy Solutions, Inc. Page 2aa


Review of the Current Price Rally

Typically, natural gas price rallies are initiated by some type of underlying fundamental event. Fundamentals involve physical events that impact supply and demand. These events could be weather-related, involving colder weather or hurricane activity. These events might also include an outlook for natural gas storage inventories or projected de-mand due to a slowing or growing economy. On the first day of 2008, physical natural gas prices in the spot market and natural gas NYMEX contract prices jumped dramatically. The front-month natural gas NYMEX contract, which at that time was February 2008, soared $.50 per MMBtu in a single day to settle at $7.85 per MMBtu, a price level that was surprising given the record-warmth throughout much of the nation during the first week of January. But then forecasts of colder weather during the third week of January provided additional upward momentum and within one week the February 2008 natural gas NYMEX contract successfully surpassed the $8 per MMBtu price level. Despite these colder temperatures in January, there was still wide consensus that temperatures in February would be very mild and considerably warmer than those experienced in February 2007. Expectations were that with the mild February temperatures, natural gas storage inventories would be between 1,500 billion cubic feet (Bcf) and 1,600 Bcf by the end of March. Prior to the cold weather hitting in mid-January, natural gas prices on the NYMEX rose, but when the cold weather actually hit, that is when there were significant price spikes in the physical spot market, par-ticularly in regions of the Midwest and Northeast. This is not unusual during periods of colder weather, and it is typi-cally viewed as a weather-driven event that subsides when the weather moderates. However, during the last week of January, nearly all February forecasts were revised and the wide consensus for above normal temperatures in February flipped to expectations of normal or below normal temperatures, particularly for the eastern half of the nation. Expectations of storage inventories is another fundamental factor that can cause natural gas prices to fluctuate. The Midwest and the Northeast rely heavily on storage to meet natural gas heating demand during the winter. When storage inventories are projected to fall to the lower end of historical ranges by March 31, it means that storage injections will need to be higher during the April through October injection season to insure adequate storage inventories for the following winter. The pace of storage injections is impacted by hurricane activity, which can involve the shut-in of supplies, and hotter weather, which means natural gas that may have been earmarked for storage could be diverted to natural gas-fired electric generation to meet air conditioning needs. While storage inventories are a little lower than originally expected, Attachment B provides an illustration of how we be-lieve storage inventories will ultimately compare to last year and the five-year average. Conclusion: The colder weather of mid-January and changing weather forecasts in the last part of January for the month of February, provided support for physical natural gas prices and natural gas NYMEX prices. As colder tem-peratures lingered, support under natural gas prices got stronger pushing the front-month natural gas NYMEX con-tract to a high of $8.48 per MMBtu in mid-January but as the colder weather moderated, the front-month natural gas NYMEX price returned to the $7.50’s. When the colder weather hit again in February, the front-month natural gas NYMEX price again moved into the mid-$8’s, a level that was comparable to what was seen one month earlier dur-ing the January cold stretch. It was at this point that analysts also started to adjust their ending storage inventory pro-jections on March 31, 2008, to something closer to 1,300 Bcf, a level that would be lower than last year but still near the five-year average. The reality is that 1,300 Bcf of storage inventories at the end of the season is still a reasonable level. Natural gas demand from the residential and commercial sector has actually been lower this year than last year plus production increases in the Barnett Shale and the successful start-up of the deepwater Gulf of Mexico Independ-ence Hub reflect a supply situation that is actually better than it was last year at this time. Therefore, we do not be-lieve that cold weather alone and lower ending storage inventories are ultimately responsible for moving the front-month natural gas NYMEX price to over $9 per MMBtu.



The Transition to a Technically-Driven Rally

We believe the current rally made a significant turn in electronic trading on Sunday, February 17, 2008. The front-month natural gas NYMEX contract settled at $8.66 per MMBtu on Friday, February 15, 2008, but in the overnight hours of Sunday, February 17, 2008, it soared to over $9 per MMBtu via electronic trading. During this weekend timeframe, Saracen Energy, a hedge fund, announced losses of $400 million to $500 million on natural gas trades that had gone the opposite way of what they had expected. It is at this point that we believe this rally turned from being primarily fundamentally-driven to one that has been primarily technically-driven. Technicals relate to the buying and selling of natural gas NYMEX futures contracts. The level of buying and selling activity on the NYMEX moves the price of monthly natural gas futures contracts prices up and down. The level of buying and selling activity on the NYMEX is tracked by the Commodity Futures Trading Commission (CFTC). The CFTC issues a report each Friday, called the Commitment of Traders Report, that shows the volume of long and short positions for all natural gas NYMEX contract months being traded.

• An entity that holds a long position, as it relates to the futures market, is one who has bought a futures contract to establish a market position. If an entity holds one long position for a monthly natural gas NYMEX contract that has expired, that entity is obligated to accept physical delivery of a monthly volume of 10,000 MMBtus of natu-ral gas at the Henry Hub in Louisiana starting on the first day of the contract month. To avoid actual delivery of the natural gas commodity, the entity must liquidate its long position through an offsetting sale. When this is done the entity’s position is liquidated and they no longer hold a position in the market. From a profit perspec-tive, when an entity is long, they are anticipating prices to move upward (i.e. buy low, sell high).

• An entity that holds a short position, as it relates to the futures market, is one who has sold a futures contract to

establish a market position. If an entity holds one short position for a monthly natural gas NYMEX contract that has expired, that entity is obligated to deliver the monthly volume of 10,000 MMBtus of natural gas to the Henry Hub in Louisiana starting on the first day of the contract month. To avoid a physical sale of the natural gas com-modity, the entity must liquidate its short position through an offsetting purchase. When this is done the entity’s position is liquidated and they no longer hold a position in the market. From a profit perspective, when an entity is short, they are anticipating prices to move downward (i.e. sell high, buy low).

There are three types of players that are covered in the weekly Commitment of Traders Report — non-commercial, commercial, and non-reportable. The non-commercial sector is made up of large speculators and hedge funds, such as Saracen Energy. The commercial sector is made up of producers, utilities, natural gas marketers, and end users that consume natural gas. Commercial players are considered large hedgers that are directly involved with the pro-duction, processing, or merchandising of the natural gas commodity and ultimately need it for their business. The non-commercial sector and the commercial sectors hold positions that are considered “reportable” because these sec-tors must make daily reports to the CFTC about the size of their positions by commodity and by delivery month be-cause their positions tend to be over a certain threshold determined by the CFTC. The third type of player using the NYMEX are those that are grouped into the non-reportable sector. These players are considered to be the smaller speculators and hedgers who carry smaller positions and therefore don’t fall under the same daily reporting require-ments as the non-commercial and commercial players. While buyers and sellers on the NYMEX remain anonymous, it is important to recognize that for every buy or purchase, there is a sale, and for every sale, there is a purchase. If you summed up the positions of the non-commercial sector, the commercial sector, and the non-reportable sector, the result would be zero. While the sum of all positions will always be zero, prices will move up or down depending on the number of buyers and sellers. When there are more players interested in buying than selling, the sellers can re-quest a higher price, and that drives prices higher. When there are more players interested in selling than buying, sellers are forced to sell at a lower price and that drives prices down.



The Transition to a Technically-Driven Rally (cont.)

The non-commercial sector, speculators and hedge funds, have been holding an extreme net-short position since July 2007. Meanwhile, the commercial sector has been holding a net-long position. Until the last two weeks of January, each of these sectors seemed content to increase their overall net positions. In the Commitment of Traders Report for natural gas NYMEX contracts, issued January 25, 2008, for the week ending January 22, 2008, the non-commercial sector held a net-short position of (105,752) contracts, the commercial sector held a net-long position of +76,278 con-tracts, and the non-reportable sector held a net-long position of +29,474 contracts. These position levels cover all positions for all natural gas NYMEX contracts being trading — which at this time begins with the front-month natu-ral gas NYMEX contract of April 2008 and extends through December 2020. While the Commitment of Traders Report doesn’t show the details by month of who holds what, it is estimated that about 80% of all positions held (both long and short) relate to the two most current natural gas NYMEX contracts being traded, which at this time are April 2008 and May 2008. As indicated on the prior page, a player that holds a position on the NYMEX for a contract that is expiring must ei-ther liquidate that position prior to expiration or be ready to take delivery of, or to sell, the commodity of natural gas at the Henry Hub, located off the Sabine Pipeline in Louisiana. To liquidate a short-position, an entity turns around and buys the underlying commodity for the specific month. To liquidate a long-position, an entity turns around and sells the underlying commodity for the specific month. The non-commercial sector has no intention of making a physical delivery or a physical purchase, so their purpose of taking a position in the natural gas NYMEX market is purely related to making profits. This sector aims to buy low, and then sell high at a later time, or sell high and then buy low at a later time. As these players increased their net-short position to (105,752) natural gas NYMEX con-tracts, they ultimately had the goal of buying the contract back when prices fell (i.e. sell high, buy low). As the colder weather moved natural gas physical prices higher, natural gas prices on the NYMEX followed suit. As natural gas prices moved higher, prices were moving adversely to the net-short position taken by the non-commercial sector, and thus this sector was faced with growing losses. Remember, the non-commercial sector looks to the NY-MEX for purely profit-taking so if prices move adversely to their positions, at some point they need to figure out at what price level they will need to get out of or short-cover their position to avoid further losses. Each player has dif-ferent price points or threshold levels at which they believe they will have to liquidate their position in order to avoid further losses. But, when that price level or threshold is reached, these players turn into aggressive, panic buyers, driving prices even higher. As the non-commercial sector sought to buy or short-cover their positions, their aggressive buying sent a signal to the marketplace. That signal was that those holding long positions could demand a higher price. With more interested buyers than sellers, natural gas NYMEX prices moved upward further. As prices move upward, more non-commercial player price thresholds levels are hit, and another round of short-covering occurs, pushing prices even higher. This cycle can repeat itself several times. We believe the transition to a technically-driven rally occurred around February 17, 2008. While Saracen Energy probably isn’t the only non-commercial player that was forced to cover its position, the news of its losses may have caused other non-commercial players to liquidate or short-cover their positions as well, in fears that aggressive ac-tions by Saracen Energy on the NYMEX could ultimately increase their losses further or beyond their threshold.



The Transition to a Technically-Driven Rally (cont.)

Information in the Commitment of Traders Report dated February 22, 2008, for the natural gas NYMEX contract for the week ending February 19, 2008, shows that the non-commercial sector had reduced its net-short position to (77,939) natural gas NYMEX contracts, which means over the prior 30 days, this sector liquidated or bought 27,813 natural gas NYMEX contracts. The commercial sector reduced its net-long position to 49,806 natural gas NYMEX contracts, which means over the prior 30 days, this sector liquidated or sold 26,472 natural gas NYMEX contracts. The non-reportable sector also reduced its net-long position to 28,133 natural gas NYMEX contracts, which means over the prior 30 days, these players liquidated or sold 1,341 natural gas NYMEX contracts. It noteworthy to point out that the front-month natural gas NYMEX contract reached a high of $8.712 per MMBtu on November 2, 2007. At that time, that price level did not prompt much technical short-covering. Rather, at that price level, the non-commercial sector increased their net-short position by another 21,098 natural gas contracts. Increas-ing their net-short position indicated that they believed prices were at a high (i.e. sell high, buy low). Conclusion: We’ve indicated that we believe the rally that started on January 9, 2008, changed from one being driven by fundamentals to one that is being driven by technicals during the evening of Sunday, February 17, 2008. To sum it up, the front-month natural gas NYMEX contract had hit a high of $8.84 per MMBtu on Friday, February 15, 2008, before falling to settle for the day at $8.66 per MMBtu. Based on the price action, it appeared that the $8.712 prior high would be an area of staunch price resistance. However, on Sunday night, during electronic trading, the price of the front-month natural gas NYMEX contract soared to over $9 per MMBtu, easily surpassing the $8.712 per MMBtu price level that in November didn’t phase the non-commercial sector. Once the price peak of $8.712 per MMBtu was surpassed, we believe it triggered a round of short-covering, which ultimately pushed the front-month natural gas NYMEX contract to new price levels and to new threshold levels, which in turn triggered another round of short-covering and higher prices. Each time this cycle repeats, natural gas prices are pushed higher. We believe the current rally has been the product of a number of rounds of short-covering, and unfortunately, we believe there may still be a few more rounds of short-covering yet to come because of the uncertainty over near-term fundamentals and storage. While short-covering could drive this rally even higher, it is important to note that the net-short position of the non-commercial sector actually increased again to (98,644) natural gas NYMEX contracts in the most recent Commitment of Traders Report issued February 29, 2008 for positions held as of February 26, 2008. This indicates that overall this sector still seems to believe that prices are going to move down (i.e. sell high, buy low). Thus, the non-commercial sector, in general, has a greater interest in seeing lower prices in order to remain profitable for their investors.



Determining Price Resistance Levels

This technically-driven rally will peak but the question is when. This rally has shown remarkable strength and few signs of slowing down. While there is no way to know when the peak will occur, there are price levels that are viewed as areas where the current rally should encounter resistance. Sometimes a peak of a previous rally is viewed as a resistance price level for the next rally. A resistance price level is a price level where the front-month natural gas NYMEX price would have the greatest potential to peak. The rally in November 2007 pushed the front-month natural gas NYMEX contract to a reach a high of $8.712 per MMBtu so that was viewed as a resistance price level for the current rally. When this price level was easily surpassed in the evening hours of February 17, 2008, a new price level was identified where the front-month natural gas NYMEX contract should incur some resistance. The new price level for resistance became $9.05 per MMBtu, which was a prior peak hit on November 30, 2006, that marked the end of a rally that started about one month earlier. The next level of price resistance was set to occur around $9.22 per MMBtu and then $9.33 per MMBtu. The $9.33 per MMBtu level was breached when the front-month natural gas NYMEX contract reached $9.36 per MMBtu on Monday, February 25, 2008, but it then declined to a low of $8.88 per MMBtu on Wednesday, February 27, 2008. However, when the April 2008 natural gas NYMEX contract became the front-month trading NYMEX contract on Thursday, February 28, 2008, it was again up, up, up, as the contract reached as high as $9.495 per MMBtu, coming very close to the next level of price resistance of $9.50 per MMBtu. As of the date of this publica-tion, the highest price level for this rally is $9.605 per MMBtu, hit on March 3, 2008. Some analysts also identify potential price levels where a rally should incur resistance by identifying retracements of historical rallies rather than peaks. The price level of $9.915 per MMBtu is a 50% retracement of the price move down from $15.78 per MMBtu on December 13, 2005, to $4.05 per MMBtu on September 27, 2006. Using histori-cal retracements, the next price level of resistance is $10.192 per MMBtu, which would complete a technical ABC price move. The A wave is considered the price move from the $4.05 low on September 27, 2006 to $9.05 on No-vember 30, 2006. The B wave is considered the price move from $9.05 to $5.192 on August 27, 2007. The C wave completion is based on the theory that Wave A = Wave C. Wave A involved a $5 per MMBtu price move, so $5 added to the $5.192 per MMBtu on August 27, 2007 = $10.192 per MMBtu. Beyond $10.192, the next price level of resistance using retracements is around $10.40 per MMBtu. Thus, under these theories, the $9.915 per MMBtu price level should serve as staunch resistance, but if that is surpassed, the next price level of resistance is $10.192 per MMBtu and then $10.36 per MMBtu. There are also seasonal targets that are looked at as potential tops for prices. Historically, the front-month natural gas NYMEX contract rallies on average 53% from a first quarter low into mid-May. If $6.838 per MMBtu, which was hit on December 27, 2007 is considered the first quarter low, then a 53% gain reaches a front-month natural gas NY-MEX price of $10.46 per MMBtu. These price levels of resistance are often published on various websites and publications and while they are useful, they can also become fuel for a rally because if non-commercial players are concerned about upward price move-ment, when a certain price level is surpassed it may force them into short-covering mode simply because they are concerned about reaching the next published level of price resistance. This can turn a rally into a self-fulfilling prophecy because as these players short-cover they continually push prices higher. So when technicals outweigh fundamentals, it means that price moves may not seem that logical because there is now a larger number of players moving prices each day based merely on price level and the profitability or loss of their positions.



Historical Rally Price Behavior vs. the Current Rally

To better understand the current rally and what can be expected, we evaluated all natural gas prices rallies where the front-month natural gas NYMEX contract exceeded $8 and/or $9 per MMBtu since 2003. However, for purposes of this analysis we did not include any information relative to the long-term rally that occurred starting in August 2005 due to the catastrophic hurricane season because that multi-month rally was caused by extenuating circumstances involving a severe supply disruption. All other rallies analyzed, starting January 2003, were caused by short-term conditions and uncertainties. Up to this point we have been referring to the current rally as the rally that started on January 9, 2008. However, upon further evaluation, we believe you can actually subdivide that rally and break it into two separate rallies — one that started on January 9, 2008, and ended on January 22, 2008, and a second that started on January 25, 2008, and is still intact. Of course this is subject to interpretation because the ending and starting dates are so close, and some may question if the decline in prices to below $8 per MMBtu for a three-day stretch ending January 22, 2008, could be considered the end of a rally, but upon further analysis we believe the price behavior actually reflects two inde-pendent rallies and therefore that is how the rally was analyzed. The details of each rally can be found in Attachment D and a graph illustrating the daily highs and lows of the front-month natural gas NYMEX contract for January 1, 2003, through February 29, 2008, can be viewed in Attachment C. On the graph in Attachment C, each time the front-month natural gas NYMEX contract exceeded $8 per MMBtu, we assigned it a letter. Each “lettered” rally is identified on the graph, and each “lettered” rally is described in further detail in Attachment D. While this analysis contains much detail, primarily we were looking for insight on rally duration and price action following the establishment of the rally peak, and therefore concluded the following as it relates to the current rally.

Duration of Historical Rallies Technically-driven rallies tend to last a little longer than rallies driven by fundamentals. With the exception of the 2005 hurricane season and prior to the current rally that started on January 25, 2008, since 2003 there have been only 10 rallies where prices surpassed $8 per MMBtu. Of these 10 rallies, once prices exceeded the $8 per MMBtu level, on average the peak of the rally was hit within 6 trading days and the longest it took to reach a peak was 19 trading days.

• The current rally has exceeded the 19 day trading timeframe for a peak, and hasn’t showed many signs of peaking although technical signals indicate the peak is approaching.

The current rally is also exhibiting similar price behavior to the most recent rallies that occurred in that there is a lot of bouncing back and forth within a price range or see-sawing before there is a decisive break-out of that price range. Once over $8 per MMBtu, for the rally in May 2007 (H), it took 31 trading days before prices decisively broke below $8 again, and for the rally in October 2007 (I), it took 15 trading days before prices decisively broke below $8 again.

• If we take the longest duration of 31 trading days before a break below $8 per MMBtu and apply it to the current rally, it would indicate that prices will start to soften during the week of March 10, 2008. This is certainly a strong possibility if short-covering starts to dwindle and temperatures moderate as we near spring.



Historical Rally Price Behavior vs. the Current Rally (cont.)

Post-Peak Price Action

While the colder weather is supportive for higher prices, the current rally still appears to be primarily technically-driven. In analyzing historical rallies, it became clear that once the peak is reached, historically there has been a quick and substantial decline. Therefore, the next part of this analysis focuses on historical post-peak decline per-centages and how those might correlate to the current rally. Evaluation of Rallies that Exceeded $9 per MMBtu:

For the 3 rallies that have resulted in peaks over $9 per MMBtu, once the peak was established, the front-month natural gas NYMEX price declined on average 22% within 1 week of the peak being hit, and on aver-age 39% within 30 days of the peak being hit. The smallest decline within 1 week of the peak being hit was 16% and the smallest decline within 30 days of the peak being hit was 28%. Based on the peak to date as of March 3, 2008, the peak of $9.91 described on page 7, and what is considered a more severe peak scenario of $10.40 per MMBtu, these percentage declines result in the following price values: Current Peak of $9.605 Peak of $9.91 Peak of $10.40 • Average 1 week decline of 22%: $7.49 $7.73 $8.11 • Average 30-day decline of 39%: $5.86 $6.05 $6.34 • Smallest 1 week decline of 16%: $8.07 $8.32 $8.73 • Smallest 30-day decline of 28%: $6.92 $7.14 $7.49

Evaluation of Rallies that Exceeded $8.50 per MMBtu:

If we expand the concept in the prior paragraph to include prices rallies that have resulted in peaks over $8.50 per MMBtu, the results are similar. For the 5 rallies that qualify, once the peak was established, the front-month natural gas NYMEX price declined on average 20% within 1 week of the peak being hit, and on average 34% within 30 days of the peak being hit. The smallest decline within 1 week of the peak being hit was 14% and the smallest decline within 30 days of the peak being hit was 19%. Based on the peak to date as of March 3, 2008, the peak of $9.91 described on page 7, and what is considered a more severe peak sce-nario of $10.40 per MMBtu, these percentage declines result in the following price values: Current Peak of $9.605 Peak of $9.91 Peak of $10.40 • Average 1 week decline of 20%: $7.68 $7.93 $8.32 • Average 30-day decline of 34%: $6.34 $6.54 $6.86 • Smallest 1 week decline of 14%: $8.26 $8.52 $8.94 • Smallest 30-day decline of 19%: $7.78 $8.03 $8.42



Conclusions of the Current Rally

As indicated earlier, no one has a crystal ball that decisively indicates when a rally is over. At this time, the potential for another round of short-covering remains a possibility and that would mean further upside potential. The recent colder temperatures have increased uncertainty in the marketplace regarding how fast storage inventories will be drawn down. The November through March timeframe is the winter storage withdrawal period, but the lower storage is on March 31, the more aggressive storage injections need to be starting April 1. Currently, there is uncertainty over storage inventory levels starting April 1 and uncertainty over how long the colder weather may linger in the eastern half of the nation. Uncertainty tends to result in an upward bias for natural gas prices. While we believe this current rally was driven to the $9+ level because of technical short-covering, there is no argu-ing that this rally has also received some support from ongoing colder weather. However, as we enter the month of March, the number of days that temperatures dip below zero or stay in the teens, should substantially drop and there-fore, heating demand will decline as well. As heating demand declines, storage withdrawals will weaken and there will be increased clarity regarding the anticipated level of storage inventories on March 31, 2008, and the uncertainty surrounding storage that exists now will be removed. Daily fluctuations in temperature will start to become less of a price driver, but weekly storage reports will have a larger influence on price direction as actual withdraw-als are closely compared to analyst projections. Further out, the marketplace is trying to understand the delicate balance of supply and demand. Similar to the clarity surrounding natural gas storage, the outlook for natural gas demand will also become more clear over the next 60 days. As the amount of natural gas required for heating needs decreases, it is easier to evaluate natural gas demand. To date, natural gas demand in 2008 has been lower than in 2007. Not only is residential and commercial demand lower, but demand from natural gas-fired electric generation has been lower even though there has been a larger amount of nuclear generation out of service. Some estimate that demand is down as much as 4 Bcf per day in com-parison to last year, but it is always more challenging to identify that number during the colder weather. In addition, a recession would point to lower demand, but weekly economic reports continue to show mixed signals on the health of the economy, so a decline in demand cannot yet be linked directly to an impending recession. Declines in de-mand are overshadowed by colder weather. As the colder weather subsides, there will be increased clarity on whether demand is declining and if so, by how much. On the supply side, rapid growth in the Barnett Shale area of Texas and the successful start-up of the deepwater Inde-pendence Hub is expected to add at least 1.5 Bcf to 2.0 Bcf per day to domestic supplies. Unfortunately, this growth is going to be somewhat countered by projected declines of Canadian imports because of the strong Canadian dollar in comparison to the weakening U.S. dollar, recent changes imposed by the Canadian government, and lower lique-fied natural gas (LNG) imports. LNG is natural gas that is pulled out of the ground in overseas countries, liquefied by reducing its temperature to minus 260 degrees Fahrenheit, shipped in specially designed vessels across the ocean to U.S. import facilities, warmed back to a gaseous state, and then intermingled with domestically produced natural gas supplies. The U.S. remains a buyer of last resort for LNG because we don’t have long-term contracts for LNG. The well-developed storage infrastructure of the U.S. means we primarily buy LNG when other countries don’t need it and it is available at a lower cost. Given demand from other countries, LNG imports into the U.S. are projected to be about 1 Bcf/day lower than last year, but as prices have risen recently, more LNG imports will likely make their way to our nation. Forecasts of hotter summer weather have also raised some concerns over increased demand from natural gas-fired electric generation. However, it should be noted that some of the same forecasters that are calling for a hotter summer were forecasting a very mild February just 60 days ago. All in all, we believe the supply situa-tion at this time will turn out to be equal to or better than the supply situation last year because of increases in domestic production, plus with natural gas prices $1.50 per MMBtu higher than last year at this time, the in-centive to produce remains very strong.



Conclusions of the Current Rally (cont.)

As indicated previously, we believe this rally, while receiving some support from colder temperatures, is really being technically-driven. A technical rally should not be sustainable if there aren’t fundamentals to support it. So, are the fundamentals there to support it at this time? Currently, the colder weather and the anticipation of larger storage withdrawals over the next couple of weeks may be the required support to keep natural gas NYMEX prices at higher price levels. Plus, given the potential for short-covering, this rally does have the potential to march toward the upper $9’s or even $10 per MMBtu. However, based on the evaluation of post-peak price declines, a sharp decline is an-ticipated once the peak has been established. While a sharp decline is expected, we don’t expect that decline to look as attractive as declines in the past simply because of the increase in technical buying and selling on the NYMEX. Even with very similar fundamentals at the end of 2007, natural gas prices on the NYMEX were trading at a $1+ pre-mium to price levels one year earlier. This raises the question of whether we have entered a higher trading range in general. Attachment C identifies all price rallies with the exception of the 2005 hurricane season that have exceeded $8 per MMBtu. This graph also provides an illustration of the trading range (highs and lows) for the front-month natural gas NYMEX contract each trading day since 2003. Each day has a vertical line that represents the trading day, with the top of the line representing the high for the day and the bottom of the line representing the low for the day. Because of the timeframe on the graph it will be difficult to see each line but in general, the general pricing trends are visible. The graph also highlights in green what many have viewed as the primary trading range of $6-$8 per MMBtu, while the $5-$6 per MMBtu range and the $8-$9 per MMBtu price ranges are highlighted in light yel-low. If we look solely at the past two years, there are fewer instances where prices fall to below $6 per MMBtu and an increase in incidents where prices move above $8 per MMBtu. This indicates that we may be moving toward a higher primary trading range that will likely be between $7-$9 per MMBtu. Plus, since this current rally has been able to sustain the $9 level for several days, it sets the precedent that it will be easier to move over $9 per MMBtu again in the future. The current rally has had a history of moving back and forth a lot within a trading range before breaking-out to the upside. This type of see-saw pricing activity seems to be increasingly common as the last several rallies have exhib-ited this type of price behavior. Plus, the last several rallies have taken longer to peak. Based on characteristics of recent rallies, we anticipate that future rallies will be more likely to enter a period of see-saw pricing or con-gestion before breaking out to the upside and further, that it is going to take increasingly longer for a rally to peak when the technicals are outweighing the fundamentals. The current rally is also getting some psychological support from soaring crude oil prices on the NYMEX. While the two commodities are unrelated, many believe it is difficult for natural gas to decline substantially when the front-month crude oil NYMEX contract is trading in excess of $100 per barrel. While crude oil prices are being driven higher by a weakening dollar, the spring tends to be a low demand period for crude and declining demand which could be exaggerated further if the U.S. enters a recession. There is no way to determine if upward momentum from the crude oil arena will continue to flow over into natural gas because there are other times where the two commodities successfully move in completely opposite directions. Actions to Take: This analysis is designed to provide some insight into price behavior of rallies and it doesn’t provide specific buying recommendations for April 2008 and beyond other than we do expect a significant de-cline once the peak is reached. What that significant decline may look like is difficult to say, but even if this rally marches toward $10 per MMBtu, we anticipate an ultimate pullback to between $8.25 to $8.60, with the potential for a further decline to below $8 or even the mid-$7’s by June. The extent and pace of a decline will be dependent on the pace of storage injections in April and May 2008. Therefore, we would argue against be-ing an aggressive buyer of prices in excess of $9 per MMBtu.



01/01/08 - 02/29/08: Comparison of Physical Daily Prices to the Daily Front-Month

Natural Gas NYMEX Settlement Price

$7.000

$7.500

$8.000

$8.500

$9.000

$9.500

$10.000

1/2/

2008

1/4/

2008

1/6/

2008

1/8/

2008

1/10

/200

8

1/12

/200

8

1/14

/200

8

1/16

/200

8

1/18

/200

8

1/20

/200

8

1/22

/200

8

1/24

/200

8

1/26

/200

8

1/28

/200

8

1/30

/200

8

2/1/

2008

2/3/

2008

2/5/

2008

2/7/

2008

2/9/

2008

2/11

/200

8

2/13

/200

8

2/15

/200

8

2/17

/200

8

2/19

/200

8

2/21

/200

8

2/23

/200

8

2/25

/200

8

2/27

/200

8

Cos

t Per

MM

Btu

Daily Physical Gas in ChicagoDaily Physical Gas in Southern CaliforniaFront-Month NYMEX

Attachment APage 12

The price in the physical spot market (cash market) and the price of the front-month natural gas NYMEX contract tend to follow similar trends. However, prices in the physical market will respond much more directly to colder weather, and that is illustrated by the periodic price spikes in the price of gas at Chicago. Meanwhile physical prices in Southern California are lower than the NYMEX, but still following a similar trend.

U.S. Natural Gas Storage Inventories

0

500

1000

1500

2000

2500

3000

3500

400011

/01

11/1

4

11/2

8

12/1

2

12/2

6

1/10

1/24 2/

7

2/21 3/

7

3/21 4/

4

4/18 5/

2

5/16

5/30

6/13

6/27

7/11

7/25 8/

8

8/22 9/

5

9/19

10/3

10/1

7

10/3

1

In B

cf

2007-2008 Actual

2007-2008 Projections

2006-2007

2005-2006

5-Yr avg

Attachment BPage 13

Natural Gas Front-Month NYMEX Prices: 01/01/03 to 02/29/08Price Behavior When Prices Exceed $8 and $9 per MMBtu

$4.000

$6.000

$8.000

$10.000

$12.000

$14.000

$16.00001

/02/

03

03/1

7/03

05/2

8/03

08/0

7/03

10/1

7/03

01/0

5/04

03/1

7/04

05/2

7/04

08/1

0/04

10/2

0/04

01/0

4/05

03/1

7/05

05/2

7/05

08/0

9/05

10/1

9/05

01/0

3/06

03/1

6/06

05/2

6/06

08/0

8/06

10/1

8/06

01/0

3/07

03/1

6/07

05/2

9/07

08/0

8/07

10/1

8/07

01/0

4/08

A

B C D E F I

This chart reflects the the high and low trading range of the front-month natural gas NYMEX price from 01/01/03 through 02/29/08. Each trading day consists of a vertical line that reflects the daily trading range. The purpose of this chart is primarily to illustrate trading behavior when natural gas prices reach over $8 and then $9 per MMBtu. Explanations on each of these "lettered" rallies can be found in Attachment D.

JHG

Attachment CPage 14

K

In-Depth Analysis of Historical Rallies: The following represents a description of all rallies (with the exception of the multi-month long rally from the 2005 hurricane season) that occurred since 2003 that have exceeded the $8 per MMBtu price level. These rallies are iden-tified by a “letter” and are charted on Attachment C. The date identified after each letter is the day on which the front-month natural gas NYMEX contract moved over the $8 per MMBtu price level. In addition, we’ve identified the daily front-month natural gas NYMEX settlement price one trading day earlier, so that you can see how quick the rally to over $8 was, the number of trading days before the peak was reached, the cause of the rally, and the low price within a variety of timeframes following the peak of the rally. (A) February 2003: Date that Price Exceeded $8 per MMBtu: February 24, 2003 Daily Settlement Price One Day Earlier: $6.61 Trading Days to Peak: 1 Price Peak of Rally: $10.40

Rally Cause: Extremely low storage inventories and the onset of colder than expected weather. Storage levels were at only 838 Bcf at the end of February (versus projections of 1,500 Bcf at the end of Febru-ary 2008) and the National Weather Service released a weather forecast calling for very cold weather during March. The already low level of storage elevated concerns that there would not be enough stor-age to make it through the winter.

Low Price within 1 week of high of $10.40: $7.11 (32% decline from high) Low Price within 2 weeks of high of $10.40: $6.48 (38% decline from high) Low Price within 30 days of high of $10.40: $4.98 (52% decline from high) Low Price within 60 days of high of $10.40: $4.89 (53% decline from high)

(B) October 22, 2004 Date that Price Exceeded $8 per MMBtu: October 22, 2004 Daily Settlement Price One Day Earlier: $7.70 Trading Days to Peak: 7 Price Peak of Rally: $9.20

Rally Cause: Hurricane Ivan and speculative short-covering. During a two-week period, non-commercial players (speculators) reduced their net-short position by 34,354 natural gas contracts. Similarly in this most recent rally, non-commercial players reduced their net-short position by 25,256 contracts between February 5, 2008, and February 19, 2008.




Attachment D

In-Depth Analysis of Historical Rallies: (cont.)

(C) April 18, 2006 Date that Price Exceeded $8 per MMBtu: April 18, 2006 Daily Settlement Price One Day Earlier: $8.01 Trading Days to Peak: 1 Price Peak of Rally: $8.28

Rally Cause: Technical short-covering and post-2005 hurricane jitters as the 2006 hurricane season ap-proached.


(D) July 31, 2006: Date that Price Exceeded $8 per MMBtu: July 31, 2006 Daily Settlement Price One Day Earlier: $7.19 Trading Days to Peak: 3 Price Peak Reached: $8.55

Rally Cause: A prolonged heat wave which resulted in a 7 Bcf withdrawal from storage during the summer, something that is very unusual but is now a little more expected due to the level of natural gas-fired elec-tric generation.


(E) November 2, 2006 Date that Price Exceeded $8 per MMBtu: November 2, 2006 Daily Settlement Price One Day Earlier: $7.72 Trading Days to Peak: 19 Price Peak of Rally: $9.05

Rally Cause: This was a technical rally as storage was viewed as adequate and hurricane season had been a non-event. There appeared to be a large level of short-covering that pushed prices higher primarily due to uncertainty over how cold the winter would be but once $9 was tested, prices turned south quickly.




Attachment D


(F) February 5, 2007 Date that Price Exceeded $8 per MMBtu: February 5, 2007 Daily Settlement Price One Day Earlier: $7.48 Trading Days to Peak: 5 Price Peak of Rally: $8.04

Rally Cause: Colder weather anticipated for February 2007. Low Price within 1 week of high of $8.04: $7.05 (12% decline from high) Low Price within 2 weeks of high of $8.04: $7.05 (12% decline from high) Low Price within 30 days of high of $8.04: $7.02 (13% decline from high) Low Price within 60 days of high of $8.04: $6.81 (15% decline from high)

(G) April 11, 2007 Date that Price Exceeded $8 per MMBtu: April 11, 2007 Daily Settlement Price One Day Earlier: $7.87 Trading Days to Peak: 1 Price Peak of Rally: $8.01

Rally Cause: Unseasonably colder temperatures in April. Low Price within 1 week of high of $8.01: $7.44 (8% decline from high) Low Price within 2 weeks of high of $8.01: $7.25 (9% decline from high) Low Price within 30 days of high of $8.01: $7.25 (9% decline from high) Low Price within 60 days of high of $8.01: $7.25 (9% decline from high)

(H) May 3, 2007 Date that Price Exceeded $8 per MMBtu: May 3, 2007 Daily Settlement Price One Day Earlier: $7.73 Trading Days to Peak: 12 Price Peak of Rally: $8.23

Rally Cause: The formation of Andrea at the start of May put some jitters in the marketplace since hurri-cane season officially begins on June 1. This rally bounced back and forth between the $7.60’s and $8.20’s even after the peak of $8.23 was hit. Once over $8 per MMBtu, it took 31 trading days before this rally decisively moved below $8




Attachment D


(I) October 30, 2007 Date that Price Exceeded $8 per MMBtu: October 30, 2007 Daily Settlement Price One Day Earlier: $7.27 Trading Days to Peak: 4 Price Peak Reached: $8.71

Rally Cause: Forecasts for a colder start to the winter provided support to natural gas prices. Natural gas prices also received some psychological assistance from quickly rising crude oil prices. This rally was very similar to (H) in that while it peaked within 4 days, it did a lot of bouncing back and forth between the $7.60’s and $8.30’s. Once over $8 per MMBtu, it took this rally 15 trading days to decisively fall below the $8 per MMBtu level.


(J) January 9, 2008 Date that Price Exceeded $8 per MMBtu: January 9, 2008. Daily Settlement Price One Day Earlier: $7.967 Trading Days to Peak: 4 Price Peak Reached: $8.48

Rally Cause: This rally was initially caused by colder than expected weather forecasts in the middle of January. This rally reached $8.48 in mid-January before falling to below $8 again. One could look at this rally as still in progress but after further evaluation, we believe this rally actually concluded at the end of January. After trading over $8 for eight trading days, the front-month natural gas NYMEX price fell to below $8 for three consecutive trading days. While we’re treating this as a concluded rally, others may argue that this rally is still underway.

Low Price within 1 week of high of $8.48: $7.63 (10% decline from high) Low Price within 2 weeks of high of $8.48: $7.57 (11% decline from high) Low Price within 30 days of high of $8.48: $7.57 (11% decline from high) Low Price within 60 days of high of $8.48: ??



Attachment D

In-Depth Analysis of Historical Rallies: (cont.) (K) January 25, 2008 Date that Price Exceeded $8 per MMBtu: January 25, 2008 Daily Settlement Price One Day Earlier: $7.802 Trading Days to Peak: ?? Price Peak Reached: ??

Rally Cause: This rally was initially caused by significantly changing weather forecasts for February. In mid-January there was still wide consensus for above-normal temperatures for much of the nation in February, but during the last week of January these forecasts changed significantly to reflect below nor-mal temperature conditions for many parts of the nation. This rally was initially driven by fundamentals of changing weather forecasts, but it received an additional boost around February 11, 2008, once the cold weather set in and the front-month natural gas NYMEX price climbed to $8.85 per MMBtu. How-ever, additional upward momentum to over $9 per MMBtu occurred on Sunday, February 17, 2008, as price drivers shifted from fundamentals to technicals. To date this rally has reached a high of $9.605 per MMBtu on March 3, 2008, marking the 26th trading day over $8 per MMBtu. Overall, significantly changed forecasts showing much colder than expected weather in February caused the natural gas indus-try to focus on storage levels. Storage levels were expected to be around 1,500 Bcf at the end of March, but now they will be closer to 1,300 Bcf, which is still well within the five-year average. This rally could almost be broken into two pieces – the first half of it appeared to be due to fundamentals of colder weather but the second half, which has taken it over $9, appears to be technically driven, as a hedge fund announced huge losses and non-commercial players covered 25,256 of their short positions.

Similarities to Other Historical Rallies:

• From a duration perspective, it took Rally (H) 31 trading days to decisively fall below $8 per MMBtu. If we use that timeframe for the current rally, it would target a pullback in natural gas prices the week of March 10, 2008. This rally is close to entering uncharted territory relative to dura-tion, but moderating weather forecasts should start to set in by the week of March 10, 2008. Even if temperatures remain below-normal, below normal in March should be significantly different than below-normal in January and February as heating demand tapers off considerably.

• From a technical rally perspective, the current rally also has some similarities to Rally (E). In that rally, natural gas prices remained over $8 for 21 trading days. Once the peak of $9.05 was reached, there was a substantial price decline of 20% within 10 trading days. This rally has extended further into the $9 price level and has the potential to extend even further, but the potential for a quick de-cline should not be discounted once the peak is hit. The same speculators that are responsible for pushing prices higher due to short-covering, will at some point decide prices have reached a level that is attractive for selling, and aggressive selling can push prices lower quickly.



Attachment D

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Analysis of Rallies 02-24-08 - Energy Solutions

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