January 16, 2019

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Natural Gas Pulls Back After 20% Rally As Near-Term Outlook Moderates From Bitterly Cold To Just Very Cold; EIA Forecast To Announce Another Bearish Inventory Draw Today As Bulls' Patients Gets Tested; Gas Demand To Fall For A Second Day Today As Northeast Warms Despite Early Arctic Air Across The Northern Plains

6:00 AM EDT, Wednesday, January 16, 2019
Natural gas retreated yesterday after Monday's 16% spike as the near-term outlook moderated somewhat and investors took profits following a 21% 2-day run-up. After trading as high as $3.72/MMBTI in pre-market electronic trade, the commodity quickly gave up these gains and moved lower throughout the day, with the front-month February 2019 contract closing down 9 cents or 2.5% at $2.50/MMBTU.The March 2019 contract, currently held by 3X ETFs UGAZ and DGAZ, closed at $3.25/MMBTU, a robust 25-cent backwardation. After the 2:30 PM EDT close of commodities trading, natural gas continued lower, ending near $3.44/MMBTU at 4PM EDT and, as a result, ETFs gave the appearance of underperformance with UNG--which still holds February 2018 contracts--falling 3.5%. Besides profit-taking, natural gas also faced downward pressure as both the GFS and the ECMWF trended less bitterly cold in the 14-day timeframe, as shown in the Figure to the right. Make no mistake, an arctic outbreak--several of them, actually--are still coming, but compared to Monday, it now appears that the initial shot of arctic air may be blunted somewhat as it moves towards the Eastern Seaboard early next week as a powerful winter storm takes more of an inland track. Additionally, temperatures now look to bounce back more sharply than previously expected before the next reinforcing shot arrives around January 25th. On the other hand, the CFSv2 long-term model has steadily trended colder over the past 24 hours and is now closely aligned to the twice-weekly ECMWF-EPS long-range model. Click HERE for more on the near- and long-term temperature outlook on my Advanced Models Page. Despite the moderation in the near-term temperature outlook, I am still forecasting a pair of very bullish draws over -200 BCF for the last two weeks of January, sufficient to drive the storage deficit back to near -450 BCF by February 1st. And with both the CFSv2 and ECMWF-EPS indicating that a pattern favoring a colder-than-normal set-up could persist throughout February, this deficit has the potential to move higher.

With yesterday's pullback, natural gas' undervaluation versus its Fair Value widened to 10% versus a Fair Price of $3.84/MMBTU based on current inventories alone. Additionally, the moderation in the near-term outlook only reduced my projected 4-week natural gas Fair Price from $4.05/MMBTU to $4.03/MMBTU meaning that, following the correction, the commodity is now trading at a steeper 21%, as shown in the Figure to the right. My near-term price target for the March 2019 contract, which is used for this undervaluation calculation, is a somewhat more conservative $3.60/MMBTU, still a substantial 9.7% discount. Yesterday's pullback helped stabilize the sector and remove some of the weak-handed longs, with upside potential once again beginning to outweigh downside risk, which influenced my trading activity yesterday (see below). Click Here for more on natural gas Fair Price data.

Meanwhile, crude oil rebounded sharply following two days of small losses after Chinese officials announced aggressive steps to stimulate the sagging economy of one of the worldwide leaders in oil demand. WTI climbed $1.60 or 3.2% to close at $52.11/barrel while Brent rose a comparable $1.65 to settle at $60.64/barrel. While announcements about stimulus plans and such are capable of driving these brief rallies, it will take hard data from the EIA showing a tightening supply/demand balance to establish a base above $50/barrel and prepare for the next move higher. It does not appear that we will get that data today when the EIA releases its weekly Petroleum Status Report for January 5-11. After yesterday's close, the American Petroleum Institute (API) announced that it was forecasting a -0.6 MMbbl crude oil inventory drawdown, around 0.7 MMbbls bearish versus the 5-year average. Should such a draw verify, crude oil stocks would fall to 439.1 MMbbls while the storage surplus versus the 5-year average would rise to a new 1-year high of +34.6 MMbbls. Additionally, the API announced that it was forecasting bearish refined product storage builds of +6.0 Mmbbls for gasoline (5-year average: +4.7 MMbbls) and +3.2 MMbbls for distillates (5-year average: -0.8 MMbbls). As a result, Total Petroleum Inventories (crude oil + gasoline + distillates) are forecast to rise by +8.6 MMbbls, more than 3x the 5-year average +2.6 MMbbls. This would be yet another underwhelming Storage Report. So far, oil has managed to continue its rebound in the face of disappointing storage data, but at some point, investors are going to throw in the towel, be it today (if the API data verifies, a big "if"), or in the next couple of weeks. I expect that if the EIA reports any sort of storage withdrawal today, WTI could hold at its current level but even a small crude oil inventory build today would result in a pullback towards $50/barel near-term. Check back after 10:30 AM EDT on my Crude Oil Inventories Page HERE for the official EIA numbers.

My Oil and Natural Gas Portfolio saw a small gain on Tuesday, rising +0.4% on the session to push year-to-date gains to +8.0%. The Portfolio was driven by gains in both oil and natural gas with my DWT short profiting +8.6% on oil's rally and my UGAZ short returning +5.6% on the natural gas pullback. I made a single trade on the day, restoring one of my favorite set-ups: the short 3X ETF pair trade. With the March 2019 natural gas contract--held by UGAZ and DGAZ--falling under $3.25/MMBTU, I was reluctant to remain net short, even with the near-term temperature outlook moderating as discussed above. For this reason, at the end of the day, I shorted a large 9.7% stake short DGAZ. Thus, I am now net long 5.6% with the 9.7% DGAZ short more than offsetting my 4.1% UGAZ short from the day before. I established this pair trade rather than just covering UGAZ and shorting a 5.6% position in DGAZ because it allows me to boost total 3X ETF exposure (13.8%) without increasing net directional exposure (5.6%). With 10-day average volatility rising back above +/-3% per day with the recent price spike, leverage-induced decay will likely be exaggerated over the next few weeks as natural gas tries to find a trading range. Even if I am too aggressive flipping back to net long here, I expect that I will benefit from leverage-induced decay. At this time, I have no plans to add to my position. My price target for the March 2019 contract is $3.60/MMBTU, though this will depend on the evolution in the near-term temperature outlook. Should the pending arctic outbreak weaken further, I will also consider flipping back to net short. My sentiment towards oil is unchanged. 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. Click HERE for more on my current oil and natural gas holdings.

Natural gas demand will fall for a second straight day as mild temperatures overspread the Northeast even as the first hints of arctic air move across the far northern Plains. Boston will rise into the lower 40s today, around 10F warmer-than-normal, while Washington, DC, Philadelphia, and New York City all reach the mid-40s, 0F-5F warmer-than-normal. More extensive above-average anomalies can be found across the South with Charlotte, NC topping 60F, Nashville the upper 50s, and Oklahoma City the mid-60s, all 10F-15F warmer-than-normal. Across the far northern Plains, wind chill advisories are in effect for this morning as arctic air will make its way south from Canada with Grand Forks, ND struggling above 0F today, 20F colder-than-normal. Bismarck, ND will only reach the lower teens while Minneapolis rises into the lower 20s, 5F-10F colder-than-normal. However, for today--and the next several days--the warmth across the East will dominate the arctic air over the comparatively less populous Plains. Today's forecast mean population-weighted nationwide temperature will rise 2.7F from Tuesday to 42.2F today, 3.2F warmer-than-normal. Total Degree Days will fall to 22.4 TDDs, 4.1 TDDs fewer than normal and the 13th fewest for January 16 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 -20 BCF/day daily natural gas storage withdrawal, 5 BCF smaller than Tuesday's draw and more than 6 BCF bearish versus the 5-year average. By tonight, projected Realtime natural gas inventories will fall to near 2410 BCF while the storage deficit versus the 5-year average will contract to -315 BCF. The storage year-over-year deficit will fall to a mere -10 BCF and will be poised to flip to a surplus for the first time in 2 years on Thursday morning, though this is likely to last less than a week before flipping back to a deficit. Click HERE for more on today's projected daily withdrawal and Realtime natural gas inventories.