October 19, 2017

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Natural Gas Continues Sell-Off Despite Expectations For Exceptionally Bullish +51 BCF Storage Injection In Today's EIA Storage Report; Oil Pares Gains Despite 2nd Largest Weekly Drawdown On Record; Gas Demand Falls Today On Excessively Bearish Temperature Pattern, But Will Limit Losses Due To Tight Supply/Demand Balance

6:00 AM EDT, Thursday, October 19, 2017
Natural gas plummeted 3.7% to settle at $2.85/MMBTU on Wednesday, but the sharp pullback was not reflected in natural gas ETFs which have rotated all or most of their holdings from the November front month contract into the much less volatile December T+1 contract. As a result, UNG--which has 2/3rds of its holdings in December contracts--fell just 0.8% while the 3x leveraged product UGAZ--which has all of its holdings in December contracts--fell just 1.6%, or an unlevered 0.5%. Regardless, the sharp decline in the prompt month contract and even lesser declines in later contracts remains rather puzzling. The $2.85/MMBUT close for the November contract was the lowest for a prompt-month contract since August 8 and the February 2018 contract at $3.20/MMBTU is at seasonal lows. With the EIA poised to announce a very bullish draw in today's storage report and the temperature forecast trending cooler (if inconsistently so) over the past few days, and natural gas undervalued by over 8% based on current inventories and the December contract according to my Fair Price Model, there appears to be plenty to of near-term drivers to support prices at least closer to $3.00/MMBTU.

Crude oil, meanwhile, retreated from early-session gains but still managed to eek out a 16 cent or 0.3% gain to settle at $52.04/barrel after the EIA reported yet another bullish storage drawdown. For the week of October 7-13, the EIA reported that crude oil inventories fell by -5.7 MMbbls. This was slightly less than the API's Tuesday forecast of a -7.1 MMbbl draw, but was still exceptionally bullish versus the 5-year average +3.9 MMbbl build. It was only the 9th weekly drawdown for the October 7-13 timeframe since 1983 and the second largest after 1990's -6.8 MMbbl draw. By contrast, refined products saw small builds with gasoline stocks rising +0.9 MMbbls (5-year average: -0.8 MMbbls) and distillates rising +0.5 MMbbls (5-year average: -1.9 MMbbls), although both of these were smaller than the API's forecast builds. All told, Total Petroleum Inventories (crude oil + gasoline + distillates) fell by -4.3 MMbbls, 5.5 MMbbls bullish versus the 5-year average +1.2 MMbbls.

With the -5.7 MMbbl draw, crude oil inventories fell to 456.5 MMbbls, the lowest since January 15, 2016 while the storage surplus versus the 5-year average fell to +67.4 MMbbls, the lowest since February 13, 2015. With crude oil inventories falling over the past few weeks during a time of the year when storage typically rises, as shown in the Figure to the right, crude oil supply/demand balance is a remarkable 6.6 MMbbls/week tight versus the 5-year average. At this rate, crude oil inventories could conceivably flip to a storage deficit as early as January, although this seems perhaps unrealistically optimistic.

It is easy those with a more bearish tendency to claim that the only reason that oil inventories saw such a large draw last week was because Hurricane Nate temporarily shut in Gulf of Mexico production. The last part of that statement is true. Domestic production fell by -1.1 MMbbls/day last week to just 7.89 Mmbbls/day, an even steeper drop than that prompted by Hurricane Harvey. This temporarily tightened supply/demand balance by 7.7 MMbbls for the week, seemingly converting a +2.0 MMbbl build to a -5.7 MMbbl draw. However, Nate also shut down Gulf of Mexico refineries and as a result, oil demand fell -0.82 MMbbls/day last week to 15.439 MMbbls. Thus, the net impact of Nate on supply/demand balance was less than 0.3 MMbbls/day or 1.9 MMbbls week, which would have corresponded with a still extremely bullish -3.8 MMbbl crude oil draw, the third largest on record for the date range.

The true driver of the week's bullish draw was, once again, oil exports. After falling from a record 2.0 MMbbls/day to "just" 1.2 Mmbbls/day the week of September 30-October 6, exports jumped 0.5 MMbbls/day week-over-week as shown in the Figure to the right to average 1.8 MMbbls/day last week, the second highest mark on record, despite possible disruptions in the Gulf. Exports were up a whopping 1.4 MMbbls/day year-over-year. And with the Brent-WTI spread rose back above $6/barrel on Wednesday after Brent closed at $58.15/barrel, it is likely that exports will remain near all-time highs for the foreseeable future.

Despite the lackluster response to the report, I feel that the EIA's data once again showed a very tight petroleum supply/demand balance that should favor higher prices. Based on current crude oil and oil product inventories, oil prices are completely disconnected from historical prices at similar storage levels, trading at a massive 22% discount to my calculated Fair Price of $66.33/barrel. And with the market as tight as it is, it appears a foregone conclusion that this Fair Price will continue to rise in the coming weeks. While it is certainly possible that investors are re-valuing crude oil at new price points from historical trends due to concerns over US shale oil, a discount of this magnitude, in my mind, is unrealistic. For this reason, as I discussed with subscribers in yesterday's Investor Commentary, I remain aggressively long the commodity via three different positions.

Turning now to natural gas, the EIA will release its weekly Natural Gas Storage Report for October 7-13 this morning at 10:30 AM EDT. I am projecting a very bullish +51 BCF natural gas storage injection, 27 BCF bullish versus the 5-year average and 16 BCF bullish versus last year's build. It was a remarkably tight supply/demand market last week and I have been forced to continuously revise my projection lower as I integrated finalized pipeline data into my model, and this projection may still be too high as several elements of my model are projecting a sub-50 BCF build. Regardless, a +51 BCF build would be the single smallest weekly injection for the October 7-13 period in the last 5 years, just ahead of 2012's +52 BCF build.

The small build was driven by bullishness across all three primarily elements of supply/demand balance: temperature-dependent demand, temperature-independent demand, and supply. Temperature-dependent demand was boosted by early-week heating demand across the Rockies due to an early-season winter storm as well as persistently hot temperatures across the Deep South boosting late-season powerburn. Due to the southern heat, powerburn averaged a strong 29.3 BCF/day, up 3 BCF/day week-over-week and up more than 2 BCF/day compared to the same week last year. Temperature-independent demand was supported by record LNG exports from Sabine Pass. LNG feedgas demand was not disrupted by Nate and in fact climbed to near its current capacity of 3.0 BCF/day, tallying a new weekly record high of 20.4 BCF, up 5 BCF week-over-week. Meanwhile, domestic production was curtailed by nearly 10 BCF due to production shut-ins associated with Hurricane Nate. Nate made landfall as a fast-moving Category 1 storm late Saturday, October 7 after prompting shut-ins of nearly 80% of Gulf natural gas production. Despite the storm's passage and minimal damage to oil & natural gas infrastructure, production was slow to recover over the course of the week. After starting the week with over 2.5 BCF/day shut-in, production losses had fallen to under 0.25 BCF/day by Friday, and fell to near 0 BCF/day over the weekend. All-told, 9.8 BCF of supply was lost over the week.

Should a +51 BCF injection verify, natural gas inventories would rise to 3646 BCF while the storage surplus versus the 5-year average would fall to -35 BCF.

Because of bullishness across all three elements of supply/demand balance as discussed above, today's report does carry greater-than-average uncertainty, especially due to significant temperature independent influences (production, LNG). Nonetheless, I expect that there is definitely potential for a quick rally off yesterday's lows should today's injection come in smaller than expected. I feel that an injection under +50 BCF would be viewed as bullish with prices likely to bounce, at least back above $2.90/MMBTU before the November 2017 contract expires next week. On the other hand, I expect that a reported injection of over +55 BCF will be viewed as a disappointment--despite being historically very bullish--with prices holding steady or even moving towards $2.80/MMBTU before expiration.

Check back at 10:30 AM EDT for the official EIA storage injection 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.

Perhaps supporting the recent downtrend in natural gas, daily gas demand will weaken further today as mild temperatures dominate. It will be perhaps the worst possible temperature pattern for natural gas demand during the shoulder season: unseasonably warm weather across the northern half of the nation and cool temperatures across the south. This suppresses both early-season heating demand (north) and late-season cooling demand (south). The largest anomalies today will be across Minnesota and the Dakotas where highs in the mid-to-upper 70s will be 20F-25F warmer than average. Even across the Northeast, highs in the 60s to lower 70s will be 10F-15F warmer than normal and decidedly bearish for natural gas demand. Across the south today, highs will be at or a few degrees cooler than average with readings in the mid-to-upper 70s. Nationwide, the temperature pattern will be dominated by the absence of north-south high temperature stratification with nearly all areas regardless of latitude in the 60s or 70s, as shown in the Figure to the right. This is very bearish for gas demand. The forecast mean population-weighted nationwide temperature today will be 64.3F, 1.9F warmer than yesterday and 4.8F warmer than normal. Total Degree Days will be exceptionally bearish today at just 4.9 TDDs, 4.2 TDDs fewer than normal and the single fewest in the last 37 years dating back to 1981, which have been as high as 17.5 TDDs in 1989. Click HERE for more on today's temperature and degree day forecast. Despite the exceptionally bearish temperature pattern today, I am still projecting a daily natural gas storage injection of +13 BCF/day for today, which is only 2 BCF bearish versus the 5-year average, highlighting a tight supply/demand balance. For the week of October 14-20 that ends tomorrow, I am projecting a preliminary +68 BCF weekly storage injection, a modest 7 BCF bullish despite otherwise unfavorable temperatures. More on this projection tomorrow. In the meantime, click HERE for more details.