I had the pleasure to record a conversation about markets with my friend Connor Sarsfield on July 18, July 2016. We agreed to let me post the transcript below for your enjoyment:

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P: how would you structure a multi-legged trade on natty here?

C: Well, let's put it this way. Outside of a crazy cold winter, I think the curve is in trouble where it is now. The backwardation between the coming winter and the next winter has got a pretty risky premium built into it. If we don’t have a one-in-ten winter or a one-in-twenty winter, a decently cold winter, then it could come back in toward spot in a big way. It could happen well before that, to be honest with you.

P: But keep in mind, the curve has blown out over the next three winters. So, even if we don’t get a big winter this year, then it could happen next year or the year after. And the price movement in those years could get even bigger. Would you just buy calls for each winter hump?

C: No. I believe the backwardation will come off. The market will slip back into scenario where front falls, rest of curve falls, then it detaches and gets back to the boring contango deal again.

P: Where are the longs and shorts on the curve?

C: I guess you would do a bear spread. Short fronts, long winter, and if the market does what it is supposed to, and the backwardation unwinds, then the front will fall much lower. But I also want to short the backs, because they are the ones that could get ultimately taken down a lot. We've seen weird sell-offs where the rest of the curve moves lower, and then the next day the fronts move lower but the winters only come down a bit. Lots of shifting movements in the calendar spreads.

P: Ratchet! You showed me some writing the other day that mentioned time-averages of production. Weekend flows are usually at this level, and we are loose or tight. He also talked about cash-average spreads of the month, indexing for physical prices. I think of all the volume that has appeared in those distant winter futures contracts, and it makes me think of a concept that is 'volume-weighted' index of price. Particularly around far-dated contracts. How can we use the fact that those contracts have traded huge volume already to be like -- OK, this might be an important number.

C: Well, that was the secret clarion call during April and May. As the front was bouncing off crazy lows, the back was starting to gain a lot of momentum and volume. You wouldn’t notice that if you were staring at front month.

P: It's a big deal. Here's a question: are the prices associated with that volume acting as a ceiling or a floor in some way, and to whom?

C: Considering how hard the producers have suffered, I think they have every reason to sell into the market at those prices. If they can get three-dollar gas next may, then I expect they will sell that hard.

C: The monthly indexing is interesting because it occurs on the last four-six days that the front month contract is the lead contract. Right before expiration and the roll. Basically, all the broad cash market indexes reference this price as baseline. The fact that June contract gas settled at $1.85 was crazy because it had never settled that low in thirty years. I am still trying to decipher how that factors into it.

P: Who do you think was counterparty to all that volume getting traded three years out?

C: Good question. Some people say that a lot of length that has come into the market in those contracts is there because of how hard this thing rallied and a macro idea that prices are going to bottom out, then back hard as production drops off. A lot of big firms that don’t usually trade it have gotten heavily positioned and that money may be holding it up right now. And if that is the case, and they are wrong, then there's a big problem.

P: So what could take the market to $10?

C: Well, if production continues to drop off, over the next round of supposed pipeline maintenance projects are done, which are actually starting this week and go for another two-plus weeks. If those tie-ins come online at the end of August and don’t bring what everybody predicts in terms of supply, then we could walk into a scenario where that continues into the Fall and we maybe get a sniff of winter? That would be pretty severe. I think a lot of people are positioned as if supply will come back.

P: What the hell would make production not come back after routine maintenance?

C: Well, there is quite a bit going offline. It is a short term thing.

P: What about $10?

C: Oh, $10 would be "Production is declining, we have no idea what the hell is going on, it's crashing, no-one has any data on what happens when it gets this low, and it looks like there might be a winter after all!" Then I think you could see seven-eight bucks.

P: What about this 4TCF, four trillion cubic feet of gas number. Isn't the whole system sitting comfortably with 4TCF storage?

C: Doesn’t matter. Not if that happens, they'll just be torching through it.

P: What is the daily production like in comparison to total storage?

C: They are estimating total supply to end the summer at 4TCF here, with total capacity at approximately 4.4TCF. Currently, domestic production is at 70 BCF per day. That is 2BCF below last year. At the beginning of this year, it was around 75BCF per day.

P: So, 75BCF into 4TCF is like 80 times. Daily flow is one-eightieth of total supply. Say two and half percent. In other words, if you had 50 days of zero domestic production then you would have forgone all of your storage. That's a number I just computed on the fly here and I don’t know if it's correct, but it is an interesting number.

C: That’s pretty crazy. Regardless if you are right, natty is really reliant on daily production. That’s why it can get so volatile when production starts to drop off.

P: How low could production go? It couldn’t go to zero.

C: Not to zero. It is at 70 now, down from 75 earlier this year, and 72 last year. That is a 3-5BCF decrease in production, depending on the reference date. In contrast, last year would have seen approximately 3-4BCF increase year-year. That is huge. If it went down another 5 or 10BCF, then you would see a very different story. And it's funny because I used to buy into the idea that all of a sudden -- one week -- production was going to crater because of the decline rates. That’s not how its going to happen. A similar thing is going to happen. They are just going to back it off, and back it off, and wait for things to correct. For producers, why not let price spike, and then sell into to go drill the next round. Catching the whole curve moving in that way could be a retirement trade.

P: Pretty much! At this conference I'm going to, a company will be there that owns several uranium mines. Some of them are in situ recovery. They're not really mined as you would think -- they pump chemicals through the ground to pull out the good stuff. Turn it on -- turn it off. Fracking, right? He has the balance sheet now where he's been able to keep production turned off. Just been waiting like, "We'll be waiting for the market to come to us". The uranium market sucks, just like the natural gas market.

C: I would have thought that they would do something sooner, but maybe it's not that easy.

P: It's really not.

C: They've been hacking back rigs since I got involved in this, back in 2011. the rig count peaked at like a thousand and now it's like two hundred.

P: I'm surprised to hear rig count has been going down for four or five, yet we are two years into the price collapse.

C: If they hadn't scaled back, then it would still be going up everyday. It was crazy. 2012, production was going up two, three, or four percent a month. They couldn’t stop it. And that was the first time I saw it go under two bucks. Now it's different.

P: I hope we see a bunch of upside in natural gas. Just crazy upside.

C: Well, I would like to see it get killed again. Maybe in the next month or two? One more time, then buy winter months.

P: Why not buy options on the next three winters now?

C: The curve is out of whack.

P: Nice. Good call. Well, put some bids out on some of those illiquid OTM calls and see if you can filled on weakness in the market.

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Thanks for reading this conversation with Connor. You can look forward to another one soon and maybe even some audio recordings to go along with it!