John Kemp, Reuters

U.S. natural gas prices have tumbled by more than 10% since late May as hedge funds start to liquidate a near-record bullish position accumulated in the expectation of a tighter market that failed to materialize.

Hedge funds and other money managers reduced their combined net long position in the two main futures and options contracts linked to Henry Hub prices by 584 billion cubic feet (Bcf) in the week to May 30.

Fund managers reduced their net long position by the largest amount in any one week since November 2016 after raising it by a cumulative 1,721 Bcf during the previous 12 weeks.

Prior to the selloff, hedge fund managers held a record ratio of five long positions for every one short position, a warning sign that their position had become overstretched and was at risk from a reversal.

Fund managers have been more bullish on U.S. gas than any other energy commodity in the expectation that increasing exports plus the start-up of new gas-fired power plants would tighten gas stocks. But the rise in gas prices over the last 15 months has gradually rebalanced the market by incentivizing more gas production and encouraging power producers to switch back from gas to coal at the margin.

The number of rigs drilling for gas is up by 100 from its low in August 2016, according to oilfield services company Baker Hughes, in response to a doubling in gas prices. In addition, the number of rigs drilling for oil has risen by more than 400 since May 2016, and many of these oil wells are producing large volumes of associated gas since February 2016.

Gas output is still down compared with year ago levels, but the pace of decline has slowed and there are indications that production is about to start rising.

At the same time, higher gas prices are rationing consumption by electricity generators, especially owners of combined-cycle plants that operate as baseload and consume large volumes of fuel.

Power producers paid an average price of $3.36 per million British thermal units (MMbtu) for gas in March 2017 up from just $2.23 in March 2016. Coal costs have actually fallen to just $2.08/MMbtu compared with an average of $2.18 in the same month last year.

The shift in relative prices has spurred a modest shift in power generation away from natural gas and back toward coal.

Combined-cycle power plants ran at slightly reduced rates in March 2017 compared with March 2016 and March 2015, according to the U.S. Energy Information Administration.

Coal-fired power plants, on the other hand, saw a sharp increase in capacity utilization, running at an average of 45% of their full capacity, up from just 36% in the same month last year.

Electricity generators produced 263 terawatt-hours (TWh) of electricity from gas during the first quarter of 2017, down from 312 TWh in 2016. But power production from coal increased to 292 TWh in January-March 2017 up from 278 TWh in the same period last year.

The result is that gas stocks have remained adequate, following the normal seasonal trend fairly closely in recent weeks, rather than tightening as many bullish hedge fund managers anticipated.

The concentrated bullish position was no longer consistent with emerging indications of a more balanced market, triggering the selloff.