July 17, 2019

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Natural Gas Rout Continues As July & Early August Temperature Outlook Trends Cooler; Volatility Soars By Summertime Standards Presenting A Challenging, But Opportunistic Trading Environment; EIA Expected To Announce A Bearish Petroleum Status Report Today Led By Big Builds In Refined Products; Heatwave Cranks Up As Powerburn Likely To Set New 2019 High Today

6:00 AM EDT, Wednesday, July 17, 2019
The natural gas rout picked up steam on Tuesday as investors continued to sell-the-news in the wake of Tropical Storm Barry as Gulf of Mexico infrastructure continues to come back online and computer models maintained their relentless trend towards a late-July cooldown. The August 2019 front-month contract slumped 10 cents or 4.2% to settle at $2.30/MMBTU, the lowest close since July 3. The move continued the trend of unusual summer-time volatility in the sector. Traditionally, during the summer months, natural gas volatility slumps as the temperature outlook takes a backseat to underlying supply/demand fundamentals that typically dictate whether injections are bullish or bearish. This summer, however, domestic production holds at record highs of over 90 BCF/day, up more than 7 BCF/day year-over-year. At the same time, powerburn cooling demand has been exceptionally strong, especially on a per cooling degree day basis, averaging 37.8 BCF/day over the past 30 days, 2.4 BCF/day higher than 2018 despite cooler year-over-year temperatures. This demand strength has been driven by natural gas prices that have dropped to 3-year lows. The result is an increased dependence of day-to-day supply/demand balance on temperature. When temperatures are below-average--which has been the norm so far this season--the surge in production dominates, leading to very bearish storage injections. However, if and when temperatures warm up, the very strong powerburn per degree day rates will take over and demand will disproportionately surge, leading to a more rapid drop-off in injections that we would traditionally see with that level of warming. Thus, investors have been unusually focused on the temperature outlook, leading to a remarkably high volatility for this time of year. 10-day volatility is averaging a whopping +/-1.96% per day, more than double last year's +/-0.91% per day, as shown in the Figure to the right. As I've previously discussed, this is a boon for adept day traders and swing traders as daily moves in the 3X ETFs are regularly exceeding 10%, but is a problem for long-term long holders of these 3x ETFs, both UGAZ and DGAZ, as this volatility--both up and down--accelerates leverage-induced decay.

Tuesday's sell-off was driven primarily by a continued cooldown in the near- and extended term computer models. Both the near-term GFS and ECWMF rapidly transition from what promises to be an excessively hot weekend to below-average nationwide gas-weighted degree days (GWDDs) by around July 23-24. Both the longer term ECMWF EPS and CFSv2 suggest that below-average GWDDs could persist into the first week of August or beyond. The forecast departure from normal GWDDs are shown in the Figure to the right based on my Hybrid Model, which integrates a performance-based weighted average of the long- and short-term models listed above. As a result, my projected weekly storage injections, particularly for the weeks ending July 26 and August 2 have steadily risen and I am now projected modestly bearish weekly injections for each of these weeks following neutral builds the previous two weeks that could drive the storage deficit versus the 5-year average down to -116 BCF or so by the beginning of August. Click HERE for more on the latest near- and long-term outlook on my Advanced Model Page.

The current temperature outlook and natural gas price point makes for a challenging trading environment. On the one hand, the 7% sell-off from last week's intra-session highs is fully justified given the rather abrupt bearish trend in the temperature outlook. On the other hand, I feel that natural gas was a solid a solid 10% undervalued initially and the whole trading range needs to be shifted higher. According to my Fair Price model, the commodity is undervalued by 15% versus a Fair Price of $2.72/MMBTU and Futures contracts for January 2020--in the heart of the withdrawal season--are trading at a mere $2.73/MMBTU. Perhaps against my better judgment, I did add to my net long natural gas position on Tuesday by shorting more DGAZ and boosting total exposure to a large 10.7%, via offsetting UGAZ and DGAZ short positions. As previously discussed, I maintain these partially offsetting short positions so as to capitalize on leverage-induced decay, which will be enhanced in this high-volatility environment. An alternative strategy for those unable or unwilling to short the funds, would be to go long a 30% UNG position or a 20% BOIL position. At this time, I am maintaining a $2.60/MMBTU summertime price target, though if the current cooldown lasts longer than currently forecast, I made need to revise this lower.

Meanwhile, crude oil sold off late in the session after Secretary Of State Pompeo announced that Iran was reportedly willing to enter into negotiations over its missile program, alleviating some of the geopolitical tension that had driven prices up over 10% the previous 3 weeks. WTI finished down $1.96 or 3.3% to $57.62/barrel while Brent lost $2.13 to $64.35/barrel. It was the lowest close for the WTI front-month contract since July 5.

Perhaps adding to the selling pressure, the EIA will release its weekly Petroleum Status report for July 5-12 this morning at 10:30 AM EDT. After Tuesday's close, the American Petroleum Institute (API) announced that it was expecting a disappointing -1.4 MMbbl inventory drawdown, more than 8 MMbbls smaller than last week's draw and 1.3 MMbbl bearish versus the 5-year average. However, the real bearishness of the API's numbers comes via refined products. The Institute is expecting a so-so -0.5 MMbbl gasoline drawdown (5-year average: -1.3 MMbbls), but a massive +6.2 MMbbl distillate build, the largest injection since January and 5.5 MMbbls bearish versus the 5-year average +0.7 MMbbls. As a result, Total Petroleum Inventories (crude oil + gasoline + distillates) are expected to rise +4.3 MMbbls, 7.6 MMbbls bearish versus the 5-year average -3.2 MMbbls with all three components skewed bearish. Should such numbers verify, I would not be surprised to see WTI continue to pull back, perhaps as low as $55/barrel, when coupled with the news out of Iran. I am maintaining my $65/barrel 2019 price target out of respect for the huge builds in recent weeks, but would be unlikely to add to my small 4.1% short DWT position (providing long WTI exposure) above $55/barrel. Check back after 10:30 AM EDT on my Crude Oil Inventory Page HERE for the latest official EIA numbers.

Natural gas demand will rise today as a long-expected heatwave begins to crank up across the Central and Eastern US. Excessive Heat Warnings are up for Philadelphia where highs could reach the mid-90s while Washington, DC could also see low-to-mid 90s while Boston and New York Cities will see the upper 80s, all approaching 10F hotter-than-normal. Meanwhile, Heat Advisories will extend south from New Jersey to coastal South Carolina where highs could reach the upper 90s, also around 10F warmer-than-normal. The Heat will also build across the Central Plains where Kansas City will reach the upper 90s and Dallas will approach 100F, 5F-10F hotter than normal. This heat will expand considerably in the days to come. Overall, today's forecast departure from normal high temperature will rise 1.0F from Tuesdsay to 80.2F, 2.4F hotter than normal and a new 2019 high. Total Degree Days (TDDs) will rise to 15.3 TDDs, 0.9 TDDs greater than normal and the 9th most for July 17 in the last 38 years since 1981. Click
Based on this forecast and early-cycle pipeline data, I am projecting a +5 BCF/day daily natural gas storage injection, 1 BCF smaller than Tuesday's build and 1 BCF bullish versus the 5-year average. When my Powerburn Forecast is issued at around 11 AM EDT today, I am expecting a new 2019 high in the 44-45 BCF/day range, around 6 BCF higher than a year ago. Based on early-cycle pipeline data, I am expecting LNG feedgas demand at 5.3 BCF/day, down 0.3 BCF from Tuesday due to an unepected drop in flows to Cove Point. Demand is still up 2.5 BCF from 2018. By tonight, look for projected Realtime natural gas inventories to reach 2567 BCF while the storage deficit versus the 5-year average will inch higher to -142 BCF. Click HERE for more on today's projected daily storage and Realtime natural gas inventories.