October 11, 2018

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Pick Yourself Up Edition: Oil & Natural Gas Fade As US Markets Implode; EIA Pitches A Doubleheader Today With Neutral +90 BCF Natural Gas Storage Injection But Exceptionally Bearish Crude Oil Inventory Build Projected; Bullish Gas Demand Expected Next Week As Record Cold Looms, But Models Now Hinting At Late October Warm-Up That Could Cap Natural Gas Rally

6:00 AM EDT, Thursday, October 11, 2018
For a second straight day, natural gas rose to new 9-month highs in AM electronic trading with prices topping $3.33/MMBTU. However, once again, prices were unable to hold their ground, paring gains by Wednesday afternoon to just 2 cents or 0.6% and settling at $3.28/MMBTU.While the intra-session sell-off could be attributable to Hurricane Michael passing east of the major natural gas producing areas of the Gulf of Mexico or due to the sell-off in domestic markets, the short-term temperature forecast through late October abruptly trended milder in afternoon model runs, at least temporarily relieving fears of an early start to the withdrawal season. While the very near-term temperature outlook remains exceptionally favorable with unseasonably chilly temperatures likely across much of the eastern two thirds of the nation through October 20, I am skeptical that the commodity can sustain these gains. The driving force behind this price spike is the fear of a supply crunch this winter due to low inventories entering the withdrawal season. However, not only do the core winter months of December, January and February continue to look to be warmer-than-normal, it will be difficult if not impossible for storage levels to come under any sort of serious pressure with production up over 10 BCF/day year-over-year. Further, more near-term, most models continue to suggest a pattern shift in late October or early November favoring much milder conditions which could prolong the storage injection season--though inventories are still all but guaranteed to finish at their lowest levels in years. While it is undoubtedly a contrarian trade right now, I feel that natural gas prices will struggle to move meaningfully higher given these headwinds and have a 2018 downside price target of $3.10/MMBTU. Should natural gas rally from here, I feel that prices over $3.30/MMBTU represents a opportunity to build a short position.

Crude oil, meanwhile, succumbed to the fears that overwhelmed Wall Street on Wednesday, with WTI tumbling $1.79 or 2.4% to settle at $73.17/barrel. The commodity also likely suffered after Hurricane Michael largely spared the oil and refinery infrastructure of the Gulf of Mexico. While 42% of Gulf production was shut-in ahead of the storm as a precaution, the storm passed well east of these rigs and they will likely come back online quickly over the next 2-3 days as evacuated crews return. Brent oil fell a slightly steeper $1.91 to $83.09/barrel, but the Brent-WTI spread remains near $10/barrel and should, at least in theory, continue to support US exports.

My Oil & Natural Gas Portfolio fell with the broad markets on Wednesday, dipping -0.5%, but was spared the disasters that likely befell some portfolios yesterday. With the losses, 2018 year-to-date gains dropped to +19.9% or +24.3% annualized. The portfolio was weighed down by my two equity holdings with SLCA falling -7.7% and my recently-accumulated GLNG dipping -4.7%. My net short natural gas position stands at a robust 12.4% of my portfolio with a 21.4% UGAZ short partially offset by a 9.1% DGAZ short. As discussed previously, these offsetting positions are intended to capitalize on leverage-induced decay enhanced by the recent rise in volatility while not overexposing the portfolio in a single direction. I have repeatedly stated my intent to short more natural gas should prices top $3.30/MMBTU. However, with the near-term temperature outlook as favorable as it is, I am somewhat reluctant to overexpose myself and risk a significant drawdown should prices continue to spike. I will likely raise my threshold to add more to my net short position from $3.30/MMBTU to closer to $3.30/MMBTU. Even if I do miss the opportunity to get additional short exposure, a rally followed by a pullback will still be quite profitable for the portfolio due to the underperformance of both 3X ETFs secondary to leverage-induced decay. My largest position right now remains my Brent-WTI spread trade with a 25.3% BNO short position partially offset by an 8.5% short DWT stake. This trade will be profitable should the spread contract and I am targeting a nearly 50% reduction in the spread to $5/barrel. I have no plans to add to this position further. My net long oil exposure is trivial at around 2.5% via short DWT. Should oil continue to pull back, I will likely begin re-accumulating below WTI $70/barrel, rebuilding a long position worth 7.5%-10% of my holdings. Click HERE for more on my current oil and natural gas holdings.

It will be a busy day today for the EIA. In addition to its regularly-scheduled weekly Natural Gas Storage Report, the agency will also be releasing its Petroleum Status Report, delayed a day due to the Columbus Day Holiday on Monday.

Today's Petroleum Status Report will be released at 11 AM EDT and will cover the week of September 29-October 5. After the close of trading on Wednesday, the American Petroleum Institute (API) announced that it was forecasting a massive +9.8 MMbbl build. This would be nearly 3x the 5-year average +3.4 MMbbls and, as the Figure to the right shows, would be the single largest build for the September 29-October 5 period in the full 33 years for which EIA data is available. While inventory builds are expected this time of year due to scheduled refinery maintenance, a nearly double digit build is exceptional for any time of year. It is unclear what is driving such a bearish build. With the Brent-WTI spread averaging just under $10/barrel over the past week, one would expect US exports to be over 2 MMbbls/day which should support a tighter supply/demand balance. But with the refinery maintenance season now kicking into gear, it is certainly possible that refinery input demand has continued to slump. However, after the API's big miss last week ahead of the EIA's surprise +8 MMbbl build, it is possible that the Institute is playing catch-up and I would not be surprised to see the API-reported build considerably smaller than the API's forecast. Regardless, should a +9.8 MMbbl build verify, crude oil inventories would rise to 413.8 MMbbls, the highest since August 10, while the storage deficit versus the 5-year average would flip back to a +6.3 MMbbl inventory surplus. The year-over-year deficit would contract sharply to -48.9 MMbbls. Check back after 11:00 AM on my Crude Oil Inventories Page HERE for more on today's official EIA storage numbers.

The EIA will also release its weekly natural gas storage report for the week of September 29-October 5 this morning at 10:30 AM EDT. I am currently projecting a +90 BCF storage injection. Such a build would be right at the 5-year average but 10 BCF larger than last year's injection. As the Figure to the rights shows, a +90 BCF injection would be the third largest in the last 5 years behind only a +102 BCF build in 2014 and a +97 BCF build in 2015. The neutral injection despite otherwise favorable temperatures was driven by production at record levels and the 0.7 BCF/day Cove Point LNG export plant remaining offline. Unseasonable heat across the Southeast, Mid-Atlantic, and Ohio Valley fueled late-season powerburn, countering much of the record supply. Mean population-weighted nationwide temperatures averaged 70.0F for the week, more than 6F warmer-than-normal. Should a +90 BCF injection verify, natural gas inventories would rise to 2956 BCF while the storage deficit versus the 5-year average would hold steady near -607 BCF. The year-over-year deficit would continues its steady decline, falling to -626 BCF. Click HERE for more on this week's projected storage injection.

With the recent run-up in natural gas prices, a bearish miss could provide a near-term catalyst for a pullback. However, with unseasonably cold temperatures on the way for the next 10 days, there will be sufficient weather-driven support for natural gas that I suspect any pullback will have a pretty high floor. I expect that a reported injection over +94 BCF will be viewed as an unequivocally bearish disappointment with prices likely to at least temporarily move back below $3.20/MMBTU. On the other hand, a reported injection under +88 BCF would be viewed as a bullish surprise and could add further fuel to the natural gas rally, supporting prices over $3.30/MMBTU. A reported injection between +88 BCF and +94 BCF would be neutral versus expectations with prices equally likely to rally or pullback.

Click Here for more on current natural gas inventories and HERE for more on supply and demand data.

Gas demand will continue to rise on Friday with a +10 BCF/day daily injection expected, 1 BCF bullish versus the 5-year average. Thanks to the late-week bump in demand, I am projecting a near-average +82 BCF natural gas storage injection for October 6-12, 3 BCF larger than the 5-year average. It would, however, be 27 BCF bearish versus last year's build, enough to take the year-over-year deficit under -600 BCF for the first time since January 2018. I will have more on this week's projection in Friday's commentary, but in the meantime, click HERE form more. Looking ahead to next week, Mother Nature will really lower the boom with a potentially historic early-season arctic outbreak across most areas east of the Rockies. The coldest day of the week looks to be Monday when parts of Colorado, Texas, Oklahoma, and Kansas may be more than 30F below average with Denver falling into the upper teens and Lubbock and Amarillo in the Texas panhandle falling into the 20s. This could drive a daily storage injection on Monday of just +6 BCF/day. While demand will weaken thereafter, as the Figure to the right shows, I am still projecting daily injections to be well-below the 5-year average throughout next week and beyond. As a result, next week's natural gas storage injection could be sub-50 BCF, driving the storage deficit versus the 5-year average to new multi-year highs above -630 BCF. Thereafter, there remains considerable uncertainty, but over the last 24 hours, computer models have begun suggesting that there could be at least a temporary warm-up beginning around October 20. Click HERE for more on the near-term temperature outlook and HERE for short term natural gas demand projections.