March 11, 2019

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Near-Term Bearish on Natural Gas As Late-March Temperatures Trend Milder But Long-Term Bullish As Supply/Demand Balance Tightens Amidst Low Season-Ending Inventories; EIA Projected To Announce (Long-Anticipated) Record March Storage Withdrawal This Week; Demand Losses To Temporarily Slow Today As Winter Holds Tough Across The Heartland

6:00 AM EDT, Monday, March 11, 2019
Natural gas sleep-walked into Friday's close, completing a week largely devoid of volatility despite a highly active weather pattern. After trading to a new 5-week intraday high above $2.89/MMBTU early in the session, natural gas steadily pulled back throughout the day to finish effectively flat on the session at $2.86/MMBTU. On the week, the commodity was likewise nearly flat, rising less than 1 penny or 0.2%. As the Figure to the right shows, the impressive volatility seen during the winter has largely vanished over the past month. After average 10-day volatility topped +/-6% per day in November, +/-5% in January, and consistently exceeded year-ago levels throughout the past 3 months, volatility has rapidly retreated to within 0.1% of 2018 levels at +/-1.15% per day. On the one hand, this means that the rate of leverage-induced decay will be reduced, which should benefit those long leveraged ETFS such as UGAZ and BOIL. On the other hand, with such a level of complacency, it is less likely that natural gas will see a short-squeeze or other big short-term move. In this pattern, a low-volatility, rangebound pattern over the next month or longer is the most likely outcome.

At this time, I am near-term bearish but long-term bullish on natural gas. I will discuss each of these sentiments in turn. Over the weekend, the near- and long-term outlook has continued to trend steadily milder. Gas demand will rapidly drop this week as a powerful spring storm system across the Plains drives warm air northwards before below-average readings return for the March 15-22 period in a long-advertised late-season arctic blast. However, it is becoming increasingly apparent that this will most likely be the final shot of arctic air this season. The CFSv2 long-term model has steadily trended warmer throughout the weekend and is now calling for warmer-than-average temperatures for the entire 4-week period beginning March 24. As a result, daily withdrawals look to flip to daily injections right on schedule around March 30 with at or above-average daily builds thereafter, as shown in the Figure to the right. Additionally, this forecast, which is based on a my Hybrid Model, an integration of multiple near- and long-term model outlooks, still includes last Thursday's run of the twice-weekly 44-day ECMWF-EPS model. Based on the weekend trend in its CFSv2 stablemate, I would not be surprised to see this afternoon's updated run of that model trend warmer, which would push the late-March and early-April injections even higher. While day-to-day swings in the temperature become less important as we move out of winter and into spring, we have not yet gotten to that point and, with the grinding rally over the past few weeks built upon a forecast that consistently trended colder and for longer, the fact that we are now seeing the light at the end of the tunnel may embolden near-term bears. Click HERE for more on the near- and long-term temperature outlook on my Advanced Model Page, including today's latest run of the ECMWF-EPS model.

Additionally, the latest data on natural gas investor holdings sets natural gas bears up to take advantage of this moderating trend. You may recall that CFTC-reported natural gas money manager holding data was suspended for 4 weeks during the January government shutdown. The CFTC has since been playing catch-up, releasing data twice per week. With last week's data release, covering the week through Tuesday, March 5, we are now all caught up. As the Figure to the right shows, open natural gas long positions among money managers trading on the NYMEX have steadily declined since peaking at over 300,000 open positions during early November, falling more than 30% to under 200,000 contracts as of 3 weeks ago, which is consistent with the sell-off in natural gas prices since December. However, short interest has not recovered, not even topping 100,000 contracts compared to over 200,000 as recently as late last July. And last week, the CFTC reported that long positions jumped 18,037 contracts to 215,950 while short contracts plunged by 18,202--or nearly 25% of open interest--to 69,696 contracts, just 30,000 contracts above the 52-week low. As a result, Bullish Sentiment--the percentage of natural gas contracts held long--jumped 6% to 76%. This is within 11% of all-time highs of 87% set back in November, 3% above the 52-week average, 12% above year-ago levels, and 23% above the 52-week average. All signs point to a persistent--to widening--surplus of bulls. With less than 70,000 short contracts, I do not feel that there are enough bears in the trade to prompt a short-squeeze even if fundamentals turned more bullish. Additionally, the long trade is becoming rather crowded and, should bearish catalysts present themselves--such as warming late March and early April temperatures--weak-handed long investors could exit their positions en masse, prompting a sell-off. Click HERE for more on the latest CFTC-reported natural gas position data.

It is for these two reasons--an increasingly bearish late March/ early April outlook and the set-up for the bears to take advantage of such a pattern shift due to a surplus of longs--that the sector could be set-up for near-term weakness. As a result, I would not be surprised to see prices pull back under $2.75/MMBTU, especially if today's ECMWF-EPS run trends colder.

On the other hand, the pending warm-up will come too late to prevent natural gas inventories from falling to their lowest level in 5 years and the second lowest in 15 years. At this time, I am projecting that natural gas inventories will fall just below 1,000 BCF, bottoming near 990 BCF the week ending March 29. This would be around 640 BCF smaller than the 5-year average and, as shown in the Figure to the right, would be the second smallest in the last 5 years behind 2014's 824 BCF and would be roughly 300 BCF lower year-over-year. Based on an historical Fair Price analysis comparing prior storage/price data to this year's projected inventories, the commodity is undervalued by a massive 34% versus a Fair Price of $4.37/MMBTU. With a baseline bearishness and seasonality bringing complacency, no one, including yours truly, expects natural gas to trade near this level any time soon. However, last November, prices peaked very close to the commodity's Fair Price and thus the Fair Price could serve as a reasonable price target for the Autumn and early winter when investors tend to be the most skittish about low inventories. Click HERE for more on projected long-term natural gas inventories.

Furthermore, one of the bears' primary large term arguments is that is doesn't matter whether inventories bottom under 1000 BCF--or even 900 BCF--because record production is driving such a loose market that unless temperatures are consistently bullish, this bearish supply/demand imbalance will quickly erase any storage deficit. This may have been true last summer--before Mother Nature spoiled the bearish parade with consistently hotter-than-normal temperatures across key markets--but a combination of cheap natural gas facilitating fuel switching, rising LNG exports, and slowing production growth has resulted in a considerably tighter market this spring. Based on the most recent EIA supply/demand data through March 6 as well as gas-weighted degree day data, I calculate that the temperature-independent supply/demand balance continues to tighten, strengthening by 0.3 BCF/day week-over-week to 0.4 BCF/day tight versus the 5-year average. This means that, for any given temperature, I would expect the daily natural gas storage withdrawal to be 0.4 BCF/day larger--or bullish--compared to the same temperature with average fundamentals over the past 5 years. This is a key metric measuring the underlying health of the natural gas sector which filters out the week-to-week variability of temperature and is used to make long-term storage and price projections. As shown in the Figure to the right, the temperature-independent supply/demand imbalance was as low as 3 BCF/day loose versus the 5-year average back in December when natural gas prices were approaching $5/MMBTU, driving fuel-switching away from natural gas, and domestic production was soaring, up more than 5 BCF/day since the summer. Should the supply/demand imbalance hold in favor of the bulls as we head into the Shoulder Season, the bearish thesis that record production will rapidly cut into the storage deficit, no matter how big, before next winter, may need to be re-evaluated. Click HERE for more on the latest EIA natural gas supply and demand data. Thus, unless Shoulder Season and summertime temperatures are exceptionally bearish, this winter's multi-year high end-of-season storage deficit is not going to be erased any time soon and inventories are a threat to head into next year's storage withdrawal season under 3200 BCF.

Based on these two elements--low starting inventories and a tighter market than many seem to be anticipating that will slow the contraction of the storage deficit--I am bullish on natural gas long-term. In fact, my long-term price target for the end of 2018 is very near my Fair Price at $4.25/MMBTU. Near-term, however, I expect rangebound trading with prices restricted to the $2.70/MMBTU-$2.90/MMBTU range as withdrawals shift to injections over the next 3-4 weeks.

At this time, despite my near-term bearishness towards natural gas, I remain net long a small 3% position with an 8.2% short DGAZ stake providing short exposure partially offset by a 5.2% short UGAZ position. Rather than trying to time a pullback, I will probably just let this position ride as it is difficult to justify going short natural gas at such low inventories unless prices manage to climb above the upper bound of my expected $2.70/MMBTU-$2.90/MMBTU trading trade. Should prices trade under $2.75/MMTBU, I will consider slowly accumulating more short DGAZ with a long-term time frame in mind.

Meanwhile, returning to the here and now, the EIA will release its weekly Natural Gas Storage Report for March 2-8 this Thursday at 10:30 AM EDT. As I have discussed previously, this week's report will be a doozy. I am projecting a -217 BCF storage withdrawal, a massive 123 BCF bullish versus the 5-year average. Not only will it be the largest withdrawal all-time for the March 2-8 period, as shown in the Figure to the right, it will be the only -200 BCF every recorded during the month of March, with a -198 BCF draw from 2015 just missing out. The massive draw was driven by record cold temperatures across the plains extending all the way to the Gulf Coast. The mean population-weighted nationwide temperature for the week averaged just 39.7F, a massive 7F colder-than-normal. This drove residential/commercial heating demand north of 50 BCF/day and daily draws above -40 BCF/day on at least two days. Should a -217 BCF draw verify, natural gas inventories would fall to 1173 BCF while the storage deficit versus the 5-year average would soar to -582 BCF. Unfortunately for the bulls, this massive withdrawal has been long anticipated, likely contributed to the 12% rally over the past 5 weeks, and is already priced in. Click HERE for more on last week's projected withdrawal.

Over the weekend, natural gas demand continued a steady decline as temperatures moderated across most areas East of the Rockies. Projected daily withdrawals on Saturday and Sunday were -13 BCF/day and -12 BCF/day, still slightly bullish versus the 5-year average -8 BCF/day, but down upwards of 25 BCF from last week's peak. The decline in demand will only temporarily slow today as persistently chilly temperatures across the Plains counter building warmth across the East. Highs along the I-95 corridor will be seasonally mild today with Washington, DC reaching 60F, Philadelphia and New York City the low-to-mid 50s, and Boston near 50F, all 5F-10F warmer than normal. Larger anomalies will be found across the Southeast today with areas from Raleigh south to Atlanta reaching 70F and 80s even reaching north Florida and southern Georgia, including the city of Jacksonville. Such readings are around 10F warmer-than-normal. However, winter will be hanging tough across a large portion of the Midwest, Great Plains, and Intermountain West which will keep heating demand relatively strong. Minneapolis won't get out of the 20s today--around 12F colder-than-normal--while Oklahoma City and Dallas to the south will be stuck in the upper 50s to near 60F, around 10F below-average. Westward into the Rockies, Billings, MT and Salt Lake City will both only reach the mid-40s, 5F-10F colder-than-normal. This will blunt the warming trend across the more the populous East by shear volume of territory. As a result, today's forecast mean population-weighted nationwide temperature will actually inch lower by -0.6F from Sunday to 50.3F, still 2.3F warmer-than-normal. Total Degree Days (TDDs) will hold nearly steady at 16.8 TDDs, 0.9 TDDs fewer than normal but the 19th most for March 11 in the last 38 years since 1981. Click HERE for more on today's temperature and degree day outlook.

Based on this forecast and early-cycle pipeline data, I am projecting a -12 BCF/day daily natural gas storage withdrawal, flat versus Sunday's draw, but still 4 BCF larger than the 5-year average, thanks largely to the chill across the Central US. Temperature-independent demand will take a hit today as, based on early-cycle pipeline numbers, LNG feedgas will plunge by 2.3 BCF/day to just 2.8 BCF/day today, the lowest since early February due to a sharp dropoff in flows to Sabine Pass. The reason for this preliminary drop-off is unclear right now. Regardless, by tonight, projected Realtime natural gas inventories will fall under 1140 BCF while the storage deficit versus the 5-year average tops -594 BCF. Click HERE for more on today's projected daily storage withdrawal and Realtime natural gas inventories.