January 17, 2019

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Undervalued Natural Gas Falls For A Second Day As Near-Term Computer Models Oscillate; EIA Projected To Announce Bearish -84 BCF Storage Withdrawal Today; Oil Rises Despite Another Bearish Petroleum Status Report; Natural Gas Inventories Forecast To Flip To A Year-Over-Year Surplus Today For The First Time In Over 2 Years--But It Will Be Short-Lived

6:00 AM EDT, Thursday, January 17, 2019
Natural gas prices continued to steadily pull back following Monday's 16% rally, dropping 12 cents or 3.3% yesterday to settle at $3.38/MMBTU. Prices had risen sharply overnight Tuesday and were up more than 4% at the very beginning of the session to $3.69/MMBTU before staging what amounted to a nearly 8% intra-session reversal. The commodity has now dropped 6% in the past two sessions after rising nearly 22% in the prior two. The March 2019 contract--held by UGAZ/DGAZ and UNG--closed at $3.15/MMBTU, a substantial 23 cent backwardation. The sell-off was once again driven by investor over-preoccupation with near-term computer models. Yesterday morning, the GFS Operational model trended sharply milder, with extended periods of mild temperatures sandwiching short-lived arctic intrusions. This contrasted with earlier runs of the GFS--as well as the ECMWF which has shown very minimal warming--which showed persist arctic air with only short inter-periods of milder temperatures. To be fair, a lot depends on this arctic outbreak verifying. The natural gas storage deficit versus the 5-year average has been slashed by more than half since the beginning of December and the year-over-year deficit is poised to flip to a surplus today for the first time in two years. However, a sell-off driven by a run or two from a single model that doesn't carry the support of other models is, in my opinion, an overreaction. Indeed, the GFS flipped right back to a much colder solution for the 18Z and 00Z run which came out after markets closed, both of which again show a sustained period of arctic air with repeated reinforcing shots and only brief warm-ups. The trend of 14-day total Gas Weighted Degree Days (GWDDs) is shown in the Figure to the right highlighting the large oscillations of the GFS model over the past 24 hours. Click HERE for more on the near-term temperature outlook on my Advanced Models page.

Investors tend to become very myopic during the winter, fixating on individual model runs and not seeing the forest in spite of the trees. There is a variability with individual model runs and basing an investing strategy on any one run is akin to throwing all your money on black at the Roulette table. While it is impossible to time and quantify the magnitude of individual arctic blasts, the overall set-up for the next several weeks is likely to be very favorable for prolonged cold air across the Lower 48 with a blocking ridge over Greenland and another area of high pressure centered over Alaska. This pattern, as shown in the Figure to the right, can be quite stubborn, resulting in a prolonged period of below-average temperatures across the major population centers of the Eastern Seaboard.

Additionally, the commodity remains quite undervalued near-term. Even based on the slightly toned-down arctic outbreak, I project that natural gas is trading at a discount of 11% versus a Fair Price of $3.84/MMBTU based on current inventories that widens to a 21% discount versus a Fair Price of $4.04/MMBTU in 4-weeks after the front-month contract rolls into March and the Fair Price rises in response to a projected rise in the storage deficit. This Fair Price has fallen a total of 2 cents in response to the moderation in near-term computer models. In other words, I feel that natural gas has overreacted to the downside based on a transient warming trend in a less-reliable computer model. Indeed, for this reason, I feel that upside potential should models trend colder outweighs downside risk should models moderate. My near-term target for the front-month February 2019 contract is $4.00/MMBTU and $3.60/MMBTU for the March contract. Should the March contract manage to fall under $3.00/MMBTU, I would be an aggressive buyer of natural gas--even with warming in the near-term models.

Meanwhile, in its weekly Petroleum Status Report for January 5-11, the EIA announced Wednesday morning that crude oil inventories fell by -2.6 MMbbls. This was considerably larger than Tuesday's American Petroleum Institute's (API's) forecast of a -0.6 MMbbl draw, was bullish versus the 5-year average -1.3 MMbbl draw, and was the largest weekly storage withdrawal since November 30. With the draw, inventories fell to 437.1 MMbbls while the storage surplus versus the 5-year average contracted down to +24.4 MMbbls. However, the larger-than-expected draw was countered by bearish and larger-than-expected refined product builds, as has been a theme lately. Gasoline inventories rose by +7.5 MMbbls (5-year average: +4.7 MMbbls) while distillates jumped +3.0 MMbbls (5-year average: -0.8 MMbbls). Overall, Total Petroleum Inventories (crude oil + gasoline + distillates) rose +7.9 MMbbls, modestly bearish versus the 5-year average +2.6 MMbbls. Additionally, the EIA reported that domestic production rose 0.2 MMbbls/day week-over-week to 11.9 MMbbls/day, a new all-time high and up a massive 2.2 MMbbls or 22% year-over-year. Click HERE for more on current crude oil and refined product inventories and supply/demand data..

Once again, this was a disappointing Status Report, but once again, investors didn't care. Prices dropped immediately after the report but then rebounded for the remainder of the session and ultimately WTI closed up 20 cents or 0.4% to settle at $52.31/barrel. Brent oil did even better, rising 68 cents or 1.1% to $61.32/barrel. This was yet another speculative rally as US supply/demand balance remains loose. Investors may focused on absolute crude oil inventories alone and see that storage levels have declined 5 out of the past 6 weeks, but the majority of these draws have been tiny and bearish, averaging a mere -1.8 MMbbls. Crude oil inventories are expected to decline this time of year--the November-January period is equivalent to natural gas' winter withdrawal season. However, as the Figure to the right shows, that time is coming to an end, with the 5-year average showing consistent inventory injections beginning in mid-January. If it is inventory withdrawals that are driving the recent rally, investors may be setting themselves up for disappointment should supply/demand balance remain loose as storage levels will likely begin rising soon. As the Figure shows, I project that storage levels could rise as top 500 MMbbls by April should supply/demand balance stay unchanged. While the commodity remains undervalued by around 13% versus a Fair Price of $59.74/barrel according to my Fair Price model, this undervaluation falls under 4% by the summer should inventories rise as projected. While I remain long WTI oil and am maintaining a long-term price target of $60/barrel, should we start seeing storage builds over the next few weeks, i would not be surprised to see WTI pull back under $50/barrel.

My Oil and Natural Gas Portfolio gave up early-session gains on Wednesday as natural gas prices retreated and finished with only the third daily loss of 2019, falling -0.4%. This reduced 2019 year-to-date gains to +7.5%. I made no trades on the day and my sentiment towards my oil and natural gas positions remains unchanged from yesterday's Commentary. Click HERE for more on my current holdings.

The EIA will release its weekly Natural Gas Storage Report for January 5-11 this morning at 10:30 AM EDT. For the week, I am projecting a -85 BCF storage withdrawal, an ugly 133 BCF bearish versus the 5-year average -216 BCF storage withdrawal. As the Figure to the right shows, such a draw would be the smallest draw in the last 5 years by a nearly 100 BCF margin and only the second year during this period that did not feature a -200 BCF or larger draw. Despite a late-week bump in demand as more seasonal temperatures returned replaced unseasonable warmth across the Northeast, daily storage withdrawals were in the single digits for four out of the seven days, bottoming out on Tuesday with a -1 BCF draw, 30 BCF bearish versus the 5-year average in a single day. The driving force behind the weak demand was, of course, exceptionally mild temperatures across the major demand centers of the Eastern Seaboard with mean population-weighted nationwide temperatures averaging 45.2F this week, 0.3F warmer than the previous week and a scorching 7.3F warmer-than-normal. Should a -85 BCF draw verify, natural gas inventories would fall to 2529 BCF while the storage deficit versus the 5-year average would slide to just -331 BCF. The year-over-year deficit will end the week at -81 BCF. Click HERE for more on last week's projected draw.

Unless today's number is dramatically higher or lower than expectations, I expect that it will be largely ignored by near-term investors who are glued to the latest computer model trends. I feel that it would take a reported draw of over -92 BCF to drive prices higher in the face of warming computer models while it would take a draw of smaller than -78 BCF to prompt a continued pullback in the face of cooling models. A draw between -78 BCF and -92 BCF would be neutral versus expectations with prices equally likely to rally or pullback based on however the AM runs of the GFS and ECMWF evolve.

Check back at 10:30 AM EDT for the official EIA storage withdrawal on my Current Natural Gas Inventories Page HERE. Also, I now have weekly natural gas supply and demand statistics on my Natural Gas Supply & Demand Page HERE that should be updated between 3 pm and 4 pm EDT.

Natural gas demand will fall for a third straight day today as temperatures warm across the Great Lakes and Southern Plains. Chicago and Detroit will reach the mid-30s today, each a modest 5F warmer-than-normal. Further south, Oklahoma City will reach 60F while highs across Texas, the nation's largest natural gas-consuming state, will be generally in the 60s and 70s, all 10F-15F warmer-than-normal, suppressing heating demand. Across the major population centers of the Eastern Seaboard, temperatures will be seasonal, generally within 5F of normal ahead of a past-moving storm system that will be light snow or a mix to the region overnight. Washington, DC and Philadelphia will reach the mid-to-upper 30s, New York City the low 30s, and Boston the upper 20s, 0F-5F cooler than normal. After making inroads to the Dakotas and Minnesota on Wednesday, arctic air will not move any further south today with highs in the teens or colder restricted to areas like Bismarck, Fargo, and International Falls. Overall, the forecast mean population-weighted nationwide temperature will actually cool slightly today, falling 0.2F to 42.0F, still 3.0F warmer-than-normal. However, due to moderating temperatures across Texas and the Great Lakes, Total Degree Days (TDDs) will fall to 22.5 TDDs, 3.9 TDDs lower than normal or the 13th fewest for January 17th 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 -18 BCF/day daily natural gas storage withdrawal, 2 BCF smaller than Wednesday's draw and 8 BCF bearish versus the 5-year average. Projected Realtime natural gas inventories will fall under 2400 BCF by mid-morning today and will finish the day near 2390 BCF. The storage deficit versus the 5-year average will contract to around -308 BCF. And, for the first time since December 6, 2016, natural gas inventories will flip from a storage deficit to a storage surplus, finishing the day +11 BCF versus 2018. However, I expect this deficit total to last a grand total of 5 days before a surge of arctic air early next week quickly flips inventories back to a deficit. Click HERE for more on today's projected daily withdrawal and Realtime natural gas inventories. Gas demand will fall further on Friday as much warmer temperatures overspread the Northeast with a projected -13 BCF/day draw expected, half the 5-year average. At this time, I am projecting a -153 BCF weekly storage withdrawal for January 12-18, 32 BCF bearish versus the 5-year average. However, Friday's draw will likely represent a near-term bottom for gas demand as arctic air moves southward over the weekend. I will have much more on this week's and next week's projected draws in Friday's Commentary.