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February 20, 2019

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Precarious Natural Gas Rally Continues As Investors Eye Both Pending Arctic Outbreak & Mid-March Warm-Up; Crude Oil Reaches New 3-Month High On Falling Saudi & Veneuzelan Exports; Gas Demand To Dip Today But Realtime Inventories Will Fall Below 1600 BCF As Large-Scale Winter Storm Dominates The Nation


6:00 AM EDT, Wednesday, February 20, 2019
Natural gas resumed its cautious rally off 2-year lows on Tuesday as investors weighed the prospect of an exceptionally favorable near-term demand outlook with the prospect of a warmer-than-normal back-half of March and a loose supply/demand balance. The front-month April 2019 contract rose 3 cents or 1.3% to close at $2.66/MMBTU, a second straight day of gains following Friday's 2% move higher. The April 2019 contract, held by the 3X leveraged ETFs UGAZ and DGAZ, settled at $2.69/MMBTU. Since bottoming out at $2.55/MMBTU on February 5, natural gas is up 4.3%, but has yet to have a signature day when the bulls confidently wrest control away from the bears.The near-term outlook continues to favor unseasonably cold temperatures across much of the nation--including, eventually, the East Coast--through March 10 and I am now projecting a storage deficit that tops -500 BCF in the next month and season-ending inventories falling below 1175 BCF. However, as shown in the Figure to the right projecting the departure-from-normal gas-weighted degree day outlook for the next 44 days based on hybrid model analysis, both long-term guidance models--the ECMWF-EPS and the CVSv2--remain in good agreement on a rapid warm-up by the second week of March. With heating demand rapidly fading by that time and natural gas production again moving towards record highs, aggressively bearish investors are betting on a rapid contraction in this storage deficit. We thus continue to see a tug-of-war between the bulls and the bears with less volatility than would be expected should this same pattern set-up in November or December. At this time, the bulls have a small advantage given the large undervaluation and second lowest inventories for the date in the last 5 years. However, the closer that we get to the actual influx of arctic air beginning late next week, the more likely investors will have priced the event in. Thus, even if natural gas doesn't trade where fundamental analysis argues that it should--above $3.00/MMBTU--it is likely that the fledgling rally will run out of steam. At this time, I am maintaining a price target of $2.90/MMBTU, but this is looking increasingly like a reach target and I feel that a more realistic level might be $2.80/MMBTU before the bears stage a "sell-the-news" pullback. This being said, with prices as discounted as they are, any such pullback would likely be limited with a price floor near $2.50/MMBTU.


Meanwhile, WTI crude oil continued its steady rally on Tuesday, rising 50 cents or 0.9% to close at $56.09/MMBTU, the highest settlement for the front-month contract since November 19. Investors remain encouraged by aggressive production cuts by OPEC producers, especially Saudi Arabia, as well as geopolitical-driven export losses from Venezuela--both of which have been reflected in recent import data to the US--as well as the prospect for strong global demand as the US-China trade war appears to be winding down. With the rally, the WTI undervaluation versus a Fair Price of $60.56/barrel based on current inventories has narrowed dramatically to just 7%. With current supply/demand balance 1.7 MMbbls/week tight versus the 5-year average over the past month, this undervaluation rises slightly with Fair Prices topping $65/barrel over the summer should current trends hold, as shown in the Figure to the right. However, with prices up 32% from the December lows and US equities markets looking shaky, I would not be surprised to see prices pullback near-term, especially if we start to see demand destruction, increased drilling counts, or an equities sell-off. My long-term price target remains $60/barrel, but I would not be surprised to see prices retreat under $55/barrel as investors process recent gains and prepare for the next leg higher. Over the next few weeks, I expect that investors will be focused most closely on imports, particularly Venezuela to see the impact of the latest sanctions. Of note, due to the Presidents' Day Holiday Monday, the EIA will be releasing its weekly Petroleum Status Report on Thursday, February 21, at 11:00 AM EDT, delayed one day.


My Oil & Natural Gas Portfolio continued its steady march higher, rising +0.6% on Tuesday to push 2019 year-to-date gains to +5.7% or +43.7% annualized. Gains were driven primarily by my natural gas long position which stands at a robust 10.4% of my holdings with a 14.8% DGAZ short partially offset by a 4.4% UGAZ short so as to capitalize on leverage-induced decay without overexposing the portfolio in a given direction. As discussed above, while I feel natural gas is undervalued, I respect the influence of the bears in the sector and feel that the commodity could be heading towards a sell-the-news event once arctic air arrives next week. While my reach price target is $2.90/MMBTU, I feel that $2.75/MMBTU is more realistic and would likely begin trimming long exposure aggressively at this level in order to protect year-to-date gains, with the intention to boost long exposure again at lower prices. My crude oil trade via short DWT stands at a tiny 2.7% of my portfolio (unfortunately) but is up +18.7% from my basis. As discussed above, while I am long-term bullish on the sector, I would not be surprised to see a near-term pullback. For this reason, I will consider flipping temporarily net short position on any further strength. Rather than covering DWT and adding a UWT short, I will likely just short around a 10% stake in UWT, push net short exposure to around 7.5%. This has the added benefit from boosting 3X ETF exposure and benefiting from leverage-induced decay. Should I set up this trade, it will be a swing-trade with a downside target of $54/barrel. Of my equities holdings, my Cheniere Energy (LNG) long position remains my largest directional holding, worth 11.2% of my portfolio. The trade is up +10.7% from my basis. At this time, I plan to continue holding with a price target of $75/barrel. My cash position stands at a robust 59% of my holdings. I prefer to keep cash at 25%-50% of my holdings and will look to put cash to work over the next week or two as entry points permit. Click HERE for more on my current oil and natural gas holdings.


Based on this forecast and early-cycle pipeline data, I am projecting a -24 BCF/day daily natural gas storage withdrawal for today, down 10 BCF from Tuesday's draw but still a solid 9 BCF bullish versus the 5-year average -15 BCF/day draw. After falling to just over 1600 BCF yesterday, projected Realtime natural gas inventories will slide to around 1578 BCF by the end of the day today. Meanwhile the storage deficit versus the 5-year average will rise to -410 BCF and the year-over-year deficit will top -135 BCF. Of note, 5-year average inventories will fall below 2000 BCF today, a level that this year's storage broke through way back on January 30, more than 3 weeks ago. Click HERE for more on today's projected daily storage withdrawal and Realtime natural gas inventories.