NEW YORK, Jan 27 (Reuters) - U.S. natural gas futures for February were down nearly 6.5 percent on Monday as investors pocketed profits and sold the soon-to-expire front-month contract after gains spurred by brutally cold weather across much of the country.
The decline was the sharpest in 8 months and triggered volatility throughout a market that had seen the largest rally in 20 months the week prior.
Last week, heating demand caused front-month gas prices to climb more than 5 percent early Thursday and more than 10 percent late Friday. Prices gained 20 percent for the week.
Temperatures in the U.S. Northeast are expected to moderate in the coming days, but cold temperatures in the Midwest have pushed cash natural gas prices in some regional markets to record highs.
The front-month February contract will expire on Wednesday, further leading traders with long positions in the market to sell their stake in it.
"The shorts were fearful and rushing for the exits as prices climbed on Friday. Now it's the longs who are bailing before the price drops further ahead of the contract expiration. The volatility arises from the mismatch," said Tim Evans, an energy analyst at Citi Futures Perspective.
MDA Weather Services forecast intense cold over the eastern two-thirds of the United States for the next five days before some warmer weather moves into the East and Southeast over the next six-to-10-day period.
Temperatures in Chicago, the third-largest U.S. city, were expected on Monday to reach a high of minus 3 degrees Fahrenheit, with a wind chill making it feel more like minus 26 degrees, according to forecaster AccuWeather.com.
Front-month February natural gas futures on the New York Mercantile Exchange closed down 33.5 cents, or 6.46 percent, at $4.847 per million British thermal units.
Cash prices on IntercontinentalExchange have continued to rally in both the heavy-consuming New York region and the benchmark Henry Hub in Louisiana.
At Henry Hub gas for Tuesday delivery rose 50 cents to $5.69, the highest level since January 2010. Late trade differentials were done at an 85-cent premium to the NYMEX price, up sharply from a 20-cent premium on Friday.
Next-day Henry Hub prices averaged $3.70 per mmBtu in 2013, up from $2.77 in 2012.
Gas on New York's Transco Zone 6 pipeline rose $31.28 to an $91.26 average per mmBtu on forecasts for more cold to come to the region. The Northeast region saw record-high prices of $120 average per mmBtu last week as heavy demand for gas for heating strained the pipeline system.
In Chicago, gas on the citygate pipeline rose $30.76 to $41.31 average per mmBtu, the highest price since the natural gas began trading on the IntercontinentalExchange in 2001. The next highest price was $12.79.
VOLATILITY, SPREADS SPIKE
In technical trade, traders noted implied volatility, a key component dealers use to price options, spiked above 84 on Friday, the highest since September 2009.
Late on Friday, the CME Group Inc hiked initial margin requirements on its benchmark Henry Hub natural gas contract by 20 percent in response to the heightened volatility, a move some traders said could fuel further short-covering.
Traders said the Relative Strength Index for the front month on the NYMEX was in overbought territory. According to Reuters data, it has been in overbought territory for the fourth day in a row but was down a bit from Friday.
Midwinter prices have spiked against late winter and early spring contracts, indicating that traders expect the market to return to normal levels after the freeze.
The difference between February and March 2014 futures hit 25.5 cents, the highest since at least February 2008, while the March-April 2014 spread reached 69.1 cents, the highest since August 2009, according to Reuters data.
Withdrawals of U.S. natural gas storage are expected to increase over the next several weeks due to the forecasts of cold weather and heavy heating demand.
Early gas storage estimates for this week range from a draw of 170 billion cubic feet to 239 bcf. That compares with a 191 bcf drop a year earlier and a five-year average decline of 162 bcf for that week. The U.S. Energy Information Administration will issue that report on Thursday.
Nuclear plant outages, which create a draw on natural gas as a substitute power source, were at about 2,600 megawatts on Monday, down from 4,400 MW out on Friday. That compares with 10,300 MW out a year ago and a five-year average outage rate of 5,800 MW.