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February 15, 2019

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Volatility Is Back, Baby: Natural Gas Soars On Monday To Push Two-Session Gains To Over +20% As Multiple Arctic Blasts Likely Beginning Next Week; 2019 Year-To-Date Oil & Natural Gas Portfolio Gains Top +7.5%--But I May Have Moved Too Soon; Backwardation Puts The Bears On The Clock, But Bulls Still Need To Keep Exuberance In Check


6:00 AM EDT, Tuesday, January 15, 2019
After two weeks of predominantly small moves as investors kept a cautious eye on Mother Nature and a shrinking storage deficit, natural gas volatility has stormed back in a big way. After 4.4% rally on Friday, the commodity sprinted higher yesterday, gaining 49 cents or 15.9% to settle at $3.59/MMBTU. It was the highest close since December 27 and was the largest single-session gain since November 14 during the height of a 65% rally that took natural gas to the precipice of $5.00/MMBTU. Natural gas is now up +21% in the past two sessions alone. And with the two-day rally, natural gas prices are back up year-over-year by +14.1% after briefly falling to a year-over-year discount last week.


Natural gas price action right now is completely dependent on the weather and, on Monday, Mother Nature cooperated. Both the GFS and ECMWF trended colder still with each predicting a series of reinforcing shots of exceptionally cold arctic air as pieces of the polar vortex look to eject southward, lasting at least through the end of the month. Additionally, the long-term CFSv2 model has trended colder in its 3-6 week forecast and the twice-weekly ECMWF-EPS model, the standard for long-term model forecasts, moved sharply colder in its Monday evening run. As a result, my Hybrid Model, which integrates ECMWF ENS, GFS OP, CFSv2, and ECMWF-EPS data, is now forecasting above-average gas-weighted degree days (GWDDs) beginning on January 19 and lasting for the duration of its forecast period through February 27, as shown in the Figure to the right. This is by far the coldest 44-day run that this model has projected so far this winter and, should the current outlook verify, is likely to drive at least 2 -200 BCF weekly storage withdrawals that, by early February, could drive the storage deficit versus the 5-year average back towards -500 BCF and the year-over-year deficit back to -200 BCF after likely flipping to a small surplus this week. Following the release of the bitterly cold 18Z GFS model and then the ECMWF-EPS data, natural gas resumed its march higher in Monday evening electronic trade, gaining another 4% to as high as $3.70/MMBTU. Despite the 00Z GFS and ECMWF trending a bit warmer, prices held near this level into the early morning hours. Click HERE for more on my Hybrid Model as well as near- and long-term model trends on my Advanced Model Page.


With the rally, my calculated natural gas undervaluation versus its Fair Price narrowed to a mere 5% based on Realtime inventories, down from over 25% last week. This undervaluation widens back to nearly 18% 4 weeks from now as my projected Fair Price rises from $3.84/MMBTU to $4.05/MMBTU as the storage deficit will widen sharply as discussed above and as futures prices dive in response to backwardation. It is this last factor that is something of a secret weapon for the bulls, particularly those holding long ETFs. While the temperature outlook is indeed very favorable right now, it will inevitably warm and, as we saw last month, the storage deficit can contract rapidly thanks to record production and a loose supply/demand balance, sending prices plummeting 40% in less than 6 weeks. However, this time the bears are on the clock thanks to backwardation. The March 2019 contract--into which the 3X ETFs UGAZ and DGAZ have already rolled their funds and into which 1X UNG will do so next week--closed Monday at just $3.29/MMBTU, a 30 cent backwardation to the front-month contract. Even more impressively, the spring time futures contracts have barely budged in response to the pending arctic outbreak and April 2019 gas closed at just $2.91/MMBTU on Monday, as shown in the Figure to the right. With natural gas inventories now increasingly likely to once again be at a large deficit heading into the end of the heating season, it seems unlikely that prices will fall much below $2.90/MMBTU level, even when temperatures warm. By this time next month, natural gas ETFs will be rolling their funds into this contract. If the cold can support prices until then, natural gas bulls will effectively capture the large majority of recent gains in a price-independent manner, due to this rollover. Essentially, the bears will run out of time for natural gas to stage a major correction.


This all being said, near-term, I expect further upside to be limited. With a 21% two-session rally built entirely on a possible warming outbreak, a warming trend in the models is a significant threat to trigger a pullback. Additionally, with the storage deficit versus the 5-year average starting this outbreak 300 BCF lower than in November, this arctic outbreak does not carry the same level of fear and I do not expect to see prices reach the lofty levels of that month when natural gas came up just shy of $5.00/MMBTU. Out of respect to the exceptionally cold near-term model outlook, I am raising my price target for the February 2019 contract to $4.00/MMBTU and for the March 2019 contract to $3.50/MMBTU, both of which would require models to trend even colder for the early February period. Despite the timing issues discussed above, I do feel that above these price points, natural gas makes a very attractive near-term short as irrational exuberance associated with the pending arctic outbreak is already starting to take hold and overshadow otherwise weak underlying fundamentals. Regardless, the one thing that is likely to continue is volatility, both to the upside and downside. For this reason, I once again encourage all investors with a timeframe beyond two weeks to avoid going long the 3X ETFs, UGAZ and DGAZ, due to much higher rates of leverage-induced decay. If you get stuck holding one of these positions, you are very likely to significantly underperform. Buy or short a larger size of the 1X UNG instead or short the opposite ETF (short DGAZ to go long or short UGAZ to get short) if you can find shares and can tolerate the risk.


Meanwhile, Crude Oil slid for a second straight day on Monday as continued weak economic data out of China amid an ongoing trade war with the US raised fears of softening global demand while a rising domestic storage surplus continues to suggest an imbalanced market. Soft domestic equity markets likely also weighed on sentiment. WTI fell $1.08 or 2.1% on Monday to $50.51/barrel while Brent oil slid a steeper $1.49 or 2.5% to $58.99/barrel. My near-term sentiment towards WTI oil is unchanged. Much of the recent run-up has been built on speculation of a tightening worldwide supply/demand imbalance in response to OPEC+ production cut, a tightening that has yet to be reflected in domestic inventories as the storage surplus versus the 5-year average continues to rise to a new 1-year high. For this reason, I feel that WTI has become overheated after a more than 20% rally from the December $42.53/barrel lows and is due for a pullback. Long-term, I still view the commodity as a good investment assuming that supply/demand balance contracts as expected and, should WTI fall under $50/barrel near-term, I feel that this will be a reasonable entry point.


My Oil & Natural Gas Portfolio continued its strong start to 2019, rising another +1.3% on Monday thanks to the spike in natural gas prices. Through the year's first 9 trading days, the Portfolio is up +7.5%, having risen for 7 out of those 9 sessions. Annualized, this is on pace for +210%, although I have no expectations or delusions that it finishes anywhere near this level come December. I made two trades on the day, a rather abrupt transition from long natural gas to short natural gas in the same session. On Monday's spike above my previously discussed price target of $3.50/MMBTU, I took profits on the entirety of my 6% DGAZ short position (that had provided long exposure), realizing a +18% gain. 45 minutes later, I look the aggressive step of shorting a small 4.3% UGAZ position as prices approached $3.60/MMBTU. Based on the late Monday near-term model runs and 44-day ECMWF-EPS, I may have been too quick on the trigger to make this switch. My downside price target for this trade is $3.00/MMBTU, but with the ECMWF-EPS forecasting below-average temperatures for much of February, I am concerned that this trade may be a victim of backwardation unless the outlook trends milder soon. For this reason, I have no imminent plans to boost short exposure further unless February 2019 prices top $4.00/MMBTU and March prices top $3.60/MMBTU. These price targets are, of course, subject to change depending on what the computer models do. I do plan to hold the position because, if anything, the short 3X ETF trade should benefit from what I expect to be above-average volatility over the next several weeks, boosting leverage-induced decay. My sentiment towards WTI oil is not changed from yesterday. Should WTI fall under $50/barrel, I will look to begin reaccumulating with a goal for total exposure to top 10% should prices make it all the way back to $45/barrel. Overall, with a giant 74% cash position, my Portfolio is very defensive right now. However, with the fund already up +7.5% this year, I am not going to mindlessly throw cash at the market just to put it to work--that is a recipe for disaster. I will continue to wait on the sidelines for high-probability set-ups, including natural gas over $4.00/MMBTU or WTI under $50/barrel. Click HERE for more on my current oil and natural gas holdings.


Natural gas demand will fall today from yesterday's 2019-high as temperatures moderate across much of the Lower 48 with a return to below-average storage withdrawals expected. Unseasonably mild temperatures will stretch from the Northern Plains to New England today with Minneapolis rising into the lower 30s, Milwaukee to near 40F, and Des Moines to the low 40s, each 8F-12F warmer-than-normal. Further east, Buffalo, NY and Boston will both reach the mid-30s, around 5F warmer-than-average apiece, with the remainder of the I-95 corridor within 5F of normal. Seasonally cool temperatures will persist across parts of Texas and the Deep South today with Houston, TX and Jacksonville, FL both stuck in the upper 50s and Richmond, VA and Raleigh NC in the upper 40s, each around 5F cooler-than-normal. However, thanks to warming temperatures across the Northern Tier, today's forecast mean population-weighted nationwide temperature will rise 0.9F from Monday to 39.6F today, 0.6F warmer-than-normal. Total Degree Days will fall to 25.4 TDDs, a slight 1.2 TDDs smaller than normal and the 18th fewest TDDs for January 15 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 -25 BCF/day daily natural gas storage withdrawal for today, just under 4 BCF smaller than yesterday's draw and 1 BCF bearish versus the 5-year average -26 BCF/day draw. As a result, by tonight, I am projecting that Realtime natural gas inventories will have dropped to 2430 BCF while the storage deficit versus the 5-year average will inch lower to -324 BCF. Thanks to a huge draw this week last year, the year-over-year natural gas storage deficit will fall by 17 BCF to around -28 BCF and remains on track to flip to a storage surplus early on Thursday. Click HERE for more on today's projected daily storage withdrawal and Realtime natural gas inventories. Natural gas demand will continue to weaken through the end of the weak with daily draws fall as low as -13-15 BCF/day by Friday, driving another bearish weekly storage withdrawal, before storage withdrawals soar over the weekend and early next week as arctic air plunges southward.