January 10, 2019

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Low-Volatility Natural Gas Trading Continues, Even As Near-Term Computer Models Hint At More Legitimate Arctic Air, While Oil Rises To 1-Month High Despite Ugly EIA Report; EIA Projected Announce Exceptionally Bearish -79 BCF Natural Gas Storage Withdrawal Today--But Do Investors Really Care? Oil & Natural Gas Portfolio 2019 Gains Top +5%

6:00 AM EDT, Thursday, January 10, 2019
Natural gas volatility remained suppressed on Wednesday as the commodity scored its second straight small gain, rising 2 cents or 0.6% to $2.98/MMBTU. Since a 10% sell-off on New Years Eve, the commodity has continued to chop around in a narrow trading range between $2.94/MMBTU and $3.04/MMBTU as investors await clarity and direction from the near-term temperature outlook. As a result, 10-day average daily volatility has dropped from +/-4.3% per day to start 2019 to +/-3.9% per day as shown in the Figure to the right, up a mere +/-0.1% per day year-over-year after rising as high as +/-6% during the heady days of the November rally. Volatility is now at its lowest level since early December. On the one hand, this is bad news for day traders and swing traders who had been having a field day in the sector with 5% daily moves seemingly becoming commonplace and leveraged ETFs seeing intra-day moves of 20%-30%. On the other hand, it is good news for those holding these 3x leveraged ETFs, either long UGAZ or DGAZ, as the stabilization should result in reduced leverage-induced decay, allowing investors to more safely hold these products longer term. Thanks to much colder temperatures this time last year, current prices are down a steep 6.9% compared to 2018 when the front-month contract was trading at $3.23/MMBTU.

However, the period of low volatility may soon be coming to an end. On Wednesday, the small rally was driven by near-term computer models that trended steadily colder. The ECMWF-ENS forecasted above-average gas-weighted degree days (GWDDs) for the upcoming 14-day period for a second straight day while the GFS increased its forecast GWDDs right to historical normals in the 12Z run before inching slightly warmer overnight, as shown in the Figure to the right. Both models--and particularly the GFS--are now calling for the possibility of a more sustained arctic intrusion across the major demand centers of the Northeast beginning around January 20 and lasting at least through the end of the 14-day period as a blocking high tries to set up shop over Greenland. The longer-term ECMWF-EPS and CFSv2 are not yet on board with the staying power of this airmass, although that is certainly subject to change. Should it verify, such a pattern transition is precisely the catalyst that the bulls have been looking for and could put an end to the rapid contraction of the storage deficit over the past 6 weeks and force investors to re-evaluate the commodity's 23% undervaluation versus its Fair Price of $3.89/MMBTU. A steep undervaluation is more understandable when the pattern is highly unfavorable as it has been for the past month, but it becomes a liability for the bears when the pattern becomes abruptly more colder. It is for this reason that I have argued against risking the short trade despite what had been a favorable set-up. I am currently maintaining a $3.50/MMBTU near-term price target on the sector should the threat of a late January and early February arctic outbreak verify. See the latest near-term GFS and ECMWF data on my Advanced Models Page HERE and check back tonight for the latest run of the twice weekly 44-day ECMWF-EPS model for more insight on the possible duration of the upcoming cooldown.

In its weekly Petroleum Status Report, the EIA announced Wednesday morning that crude oil inventories fell by -1.7 MMbbls for the week of December 29-January 4. This was a 0.9 MMbbls bearish versus the 5-year average -2.6 MMbbl draw and was disappointing relative to the American Petroleum Institute's (API's) -6.1 MMbbl Tuesday forecast. With the draw, inventories fell under 440 MMbbls for the first time since November 2 to 439.7 MMbbls but the storage surplus versus the 5-year average rose to a new 52-week high of +33.9 MMbbls. The bearish draw was driven largely by imports which rose 0.45 MMbbls/day last week to 7.85 MMbbls/day, up 0.2 MMbbls/day year-over-year, the first yearly gain in over a month. Demand also slumped with refinery inputs and exports each falling 0.2 MMbbls/day week-over-week. Additionally, the EIA reported mammoth storage builds in refined products with gasoline stocks rising +8.1 MMbbls (5-year average: +6.4 MMbbls) and distillates rising +10.6 MMbbls (+7.2 MMbbls). As a result, Total Petroleum Inventories (crude oil + imports + distillates) rose a total of +17.0 MMbbls, 6 MMbbls bearish versus the 5-year average.

Overall, this was a disappointing report in essentially all aspects. It was therefore rather surprising that crude oil prices rose for a ninth straight day. WTI soared $2.56 or 5.2% to settle at $52.36/barrel, the highest close since December 13 and up 23% from December's lows near $42.50/barrel. Brent rose 4.6% to $61.44/barrel. Investors are clearly willing to overlook bearish near-term storage data on speculation that with upcoming production cuts, supply/demand balance will tighten. On the one hand, this is not unreasonable. It takes several weeks for crude-laden tankers to arrive at their destinations and imports during the reported week probably reflect exports from early- or mid-December and I would not be surprised to see imports slump over the next few weeks as they become more reflective of the late December and early January period. Additionally, even with the rising crude oil storage surplus, the commodity is still undervalued by 12% versus my Fair Price of $59.88/barrel. However, the crude oil supply/demand balance is now averaging 1.6 MMbbls/week loose versus the 5-year average over the past 4 weeks. Should this continue--and even assuming some modest tightening--this undervaluation essentially disappears by the summer with the Fair Price falling to $54/barrel, equal to that month's Futures contract, as shown in the Figure to the right. For this reason, I am fully expecting a near-term pullback in WTI prices as the market has become overheated on speculation rather than hard data. I would not be surprised to see the commodity pullback under $50/barrel, especially if equities markets pull back as well. I feel that any price in the $40s/barrel is a good entrypoint and I remain bullish long-term with a 2019 price target of $60/barrel which, of course, assumes a tightening of supply/demand balance.

My Oil & Natural Gas Portfolio rose for a fifth day in six to start 2019, climbing +1.4% to finish near the day's high and push 2018 gains to +5.5%. All five of my current holdings were up on the day, led by my long oil trade via short DWT which finished up +15.5%. I made two trades on Wednesday. First, I reduced oil long exposure when WTI topped $52/barrel despite the bearish EIA Status Report, nearly halving exposure from 5.6% to 2.9%. I feel like the sector is overheated near-term but am still long-term bullish and would begin to re-accumulate should prices fall back under $50/barrel. Additionally, with natural gas prices holding nearly flat under $3.00/MMBTU despite a cooling trend and possible more legitimate arctic outbreak developing in the computer models, I added to my natural gas position by shorting a 2% stake in DGAZ to bring total position size up to 8.3% of my holdings. This was an aggressive trade, made well-above my previously discussed threshold of $2.90/MMBTU. However, I felt that the risk/reward was favorable given the cooling trend in the models and large undervaluation. My price target for this trade is $3.25/MMBTU with a possible revision to $3.50/MMBTU should late January/early February arctic air verify. After this addition, I have no further immediate plans to add to my natural gas long position. Click HERE for more on my current oil and natural gas holdings.

The EIA will release its weekly natural gas storage report for December 29-January 4 at its regularly scheduled time of this morning at 10:30 AM EDT. I am projecting an exceptionally bearish -79 BCF inventory draw, 103 BCF smaller than the 5-year average and 258 BCF bearish versus last year's record-setting -337 BCF withdrawal. As the Figure to the right shows, this would be the smallest build in the last 5 years by a 43 BCF margin, crushing 2017's -122 BCF draw. The bearish withdrawal was driven by unseasonably mild temperatures across the eastern two-thirds of the country last week. The mean population-weighted nationwide temperature averaged 44.9F, 1.1F colder than the previous week but still 3.5F warmer-than-normal. The week also suffered from temperature-independent industrial and commercial demand losses associated with the New Years Holiday, although this is unlikely to be to the same degree as Christmas week. Should a -81 BCF draw verify, natural gas storage would fall to 2624 BCF while the storage deficit versus the 5-year average would narrow to just -471 BCF. The year-over-year deficit would be more than halved in a single week to just -194 BCF. Click HERE for more on last week's projected withdrawal.

With the possibility of more legitimate arctic air increasing in the latest computer models, I expect investors will once again overlook this week's report in lieu of following the latest model trends, unless it is exceptionally above or below analyst expectations. Even then, as last week's seemingly disastrous -20 BCF draw and yesterday's crude oil miss demonstrated, investors can become near-sighted even in exceptional cases. Regardless, I feel that it would take a reported withdrawal over -84 BCF to be considered a sufficiently bullish surprise (though the overall draw would still, of course, be very bearish) to sustain a rally above $3.05/MMBTU. I feel that it would take a draw of smaller than -72 BCF to be considered sufficiently disappointing to drive a pullback under $2.95/MMBTU even if computer models continue to trend colder. A reported draw between -72 BCF and -84 BCF would be neutral versus expectations with prices equally likely to rally or pullback.

Check back at 10:30 AM EDT for the official EIA storage withdrawal on my Current Natural Gas Inventories Page HERE. Also, I now have weekly natural gas supply and demand statistics on my Natural Gas Supply & Demand Page HERE that should be updated between 3 pm and 4 pm EDT.

Natural gas demand will rise sharply for a second straight day today as below-average temperatures reach the Eastern Seaboard after a weak of unseasonably mild weather. Highs will only rise to near 30F in Pittsburgh to the mid 30s in Louisville, KY to near 40F in Nashville, TN, 5F-10F colder-than-normal. Along the Eastern Seaboard, highs will be near to slightly above-average in the major cities with Washington, DC, Philadelphia, New York City, and Boston all rising into the lower 40s, 0F-5F warmer-than-normal. Across the Plains and Midwest, the arctic air that had made an appearance across the northern tier over the past two days will beat a hasty retreat today with highs warming into the upper 20s to lower 30s in Bismarck, ND and Minneapolis, 10F-15F warmer day-over-day and 5F-10F above-average. However, given the greater population across the Eastern Seaboard, its cooldown will be the primary driver today with the forecast mean population-weighted nationwide temperature today falling 4.7F from Wednesday to 39.3F, still 0.4F warmer-than-normal. Forecast Total Degree Days (TDDs) will rise to 25.4 TDDs today, still 1.2 TDDs fewer than normal. Click HERE for more on today's temperature and degree day forecast.

Based on this outlook and early-cycle pipeline data, I am projecting a -23 BCF/day daily natural gas storage withdrawal, 8 BCF larger than Wednesday's draw but still a bearish 9 BCF smaller than the 5-year average -31 BCF/day withdrawal. After finally dropping under 2600 BCF last night, inventories will fall to around 2568 BCF by tonight while the storage deficit versus the 5-year average contracts to -335 BCF. The year-over-year deficit will trend closer to flipping to a storage surplus by next week, sliding to just -68 BCF. Click HERE for more on today's projected daily withdrawal and Realtime natural gas inventories. Gas demand will rise for a third straight day on Friday with a projected daily withdrawal of -25 BCF/day. However, it will be too little, too late to prevent yet another exceptionally bearish weekly withdrawal. I am currently projecting a mere -81 BCF draw for January 5-11, 143 BCF bearish versus the 5-year average and the single smallest in the last 5 years by a nearly 100 BCF margin. On the bright side, draws are likely to rise back into the triple digits next week. I will have much more on this week's and next week's projected storage withdrawals in Friday's commentary.