December 13, 2017

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Natural Gas Rally Falters Amidst Temperature Outlook Oscillation & Inconsistency, But Potential For Late December Chill Increasing; Natural Gas Demand To Climb Today As Midwest Cools; Storage Deficit Versus 5-Year Average Likely To Again Exceed -50 BCF By Tonight As Undervaluation Versus Fair Price Rises

6:00 AM EDT, Tuesday, December 12, 2017
Natural gas rebounded nearly 6 cents or 2% on Monday to settle at $2.83/MMBTU after early-morning computer model data suggested a colder end to the month. However, early afternoon runs of these same models flipped back to a warmer outlook and prices took a downturn after commodities trading ended at 2:30 PM EDT. As a result, the ETF UNG finished with a mere 0.5% gain and UGAZ was only up 2.2%.

Natural gas futures contracts through November 2018 remain under $3.00/MMBTU, as shown in the Figure to the right. There is one bright spot for natural gas bulls here. Despite the recent sell-off, contango-related rollover losses for natural gas ETFs should be minimal for the next several months. The February 2018 contract is only trading at a 1 cent premium to the current Front Month January 2018 contract meaning that the current rollover--which is 60% complete for UGAZ and will begin next week for UNG--will see a minor 1% price independent loss. Thereafter, prices drop nearly 5% to $2.71/MMBTU by April, a rare backwardation for the sector. Should natural gas find its legs and stage a winter rally, this backwardation could widen further. Should the commodity continue to sell-off towards $2.50/MMBTU, it is likely that contango would re-establish itself.

WTI crude oil, meanwhile, rallied 63 cents or 1.1% to end the day at $57.99/barrel, erasing much of last week's 1.7% loss in a single session. Brent crude did even better, rising $1.29 or 2% to $64.69/barrel after the important North Sea Forties pipeline was shut down for up to 3 weeks after a crack was discovered, cutting takeaway capacity for up to 40% of North Sea Production. It was the highest close for Brent since June 11, 2015. As a result of the Brent outperformance, the Brent-WTI spread rose to $6.70/barrel which could push US exports back towards the recent record high above 2 MMbbls/day in coming weeks. My Oil & Natural Gas Portfolio was essentially flat on the day, rising 0.04% as returns since May 1 held steady at +27.9%.

As a reminder, submissions for Week 6 of my Natural Gas Storage Contest close today at 5pm EDT. Entrants will be submitting their projection for the natural gas storage week of December 2-8 that ended last Friday and the closing price of natural gas (January 2018 front month contract) this Thursday, the day the EIA releases its official report for that storage week. The contest now has over 100 participants competing for $400 in prizes. Click HERE to read contest rules, see the latest rankings and to submit your picks.

Natural gas demand will rebound today after Monday's dip as a reinforcing shot of arctic air moves south across the Plains, Great Lakes and Midwest. Chicago, Columbus and Detroit will only see mid-20s today, 10F colder than yesterday and 10F-15F colder than normal. The Northeast will see seasonally cool temperatures as a coastal storm brings rain to the I-95 corridor and heavy snows inland. Highs from Washington, DC to Boston will be in the low-to-mid 40s, 0F-5F cooler than normal while Pittsburgh to Buffalo will rise to near the freezing mark, around 5F colder than normal as a lake effect snow event begins tonight and could bring up to 30 inches to the favored areas over the next few days. The Rockies and western Plains will remain well above-average today with Billings, Mt and Denver both rising to around 60F, while Bismarck, ND could see 50F, all around 20F warmer than normal. However, thanks to the much higher population across the East, today's forecast population-weighted mean nationwide temperature will fall 0.4F day-over-day to 43.0F, still 0.9F warmer than normal. Total Degree Days will rise to 21.6 TDDs, 2.2 TDDs fewer than the long-term average and the 18th fewest TDDs in the last 38 years. 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 -22 BCF/day daily natural gas storage withdrawal, 3 BCF larger than Monday's draw and 4 BCF bullish versus the 5-year average -18 BCF/day withdrawal. By the end of the day, I project that natural gas inventories will have dropped below 3550 BCF while the storage deficit versus the 5-year average will be closing in on -50 BCF, up from a +5 BCF intraweek storage surplus just 1 week ago. Click HERE for more on today's projected daily withdrawal and intraday natural gas inventories.

Looking longer term, the dominant pattern for the remainder of 2017 will remain largely the same. It is the particulars of this forecast that will determine where natural gas inventories will start 2018. A trough will persist across the northeastern tier, with the exception of a few days late next week, allowing Canadian air to move south over Minnesota and Wisconsin across the Great Lakes and into the Northeast while a ridge across the South allows mild air to move north across the Rockies, southern Plains and Southeast. Wednesday, Thursday and Friday, this trough will amplify allowing much colder than average temperatures across the East to win out over the western ridge and drive daily natural gas storage withdrawals in excess of -25 BCF. By early next week, the trough will shift north into southern Canada and the ridge will win out, dropping daily withdrawals perhaps into the single digits. It is the period thereafter, beginning around December 23 where the forecast becomes uncertain. Both the American GFS and European ECMWF at minimum show an equilibrium being reached with seasonally cool temperatures across the Northeast and Great Lakes while mild weather will dominate the Rockies and Texas. This is the solution shown in the NWS 10-14 day temperature outlook, as shown in the Figure to the right. However, intermittent runs of both models have shown an aggressively cold outlook in which the northern trough becomes much more amplified and dives south, bringing arctic air across much of the East. It was this forecast that drove natural gas to rise over 2% early yesterday, and its absence that dropped prices sharply late in the afternoon. Should this colder forecast become more consistent in upcoming model runs, expect natural gas prices to rally towards $3.00/MMBTU as the natural gas storage deficit could very quickly exceed -150 BCF before the end of the year. But even the more neutral pattern is at least modestly favorable to natural gas demand with colder-than-average temperatures across major demand centers from Chicago and Milwaukee to Detroit, Pittsburgh, and the Megalopolis while the warmth is expended on the sparsely-populated Rockies and across the Deep South that is already rather mild and contributes to heating demand to a lesser extent. Click HERE for more on the extended term temperature outlook.

After the projected -63 BCF withdrawal for this Thursday's EIA report drops the natural gas storage deficit versus the 5-year average dips to around -20 BCF, (and likely flipped briefly to a storage surplus intra-week), the deficit will likely see rebound back above -100 BCF by the end of the year, as shown in the Figure to the right. Should the bitterly cold forecast variant verify, the storage deficit by December 29 could very well be in excess of -150 BCF. However, even based on the current projection showing a more modest deficit of around -125 BCF, natural gas would still be significantly undervalued by an enormous 20% versus a Fair Price of $3.54/MMBTU. While I believe that such a price is likely out of reach no matter how cold it gets this winter, I feel that natural gas could very quickly rally to $3.00/MMbtu should a colder pattern present itself. While significant downside risk remains in the sector, particularly later this winter and into the spring depending on the evolution of a possible supply/demand mismatch, I feel that, at least near term, upside potential outweighs downside risk.