December 20, 2018

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Volatile Natural Gas Searches For Direction As Computer Models Suggest Return To Colder Temperatures By The New Year Even As Near-Term Demand Plunges; EIA Forecast To Announce Slightly Bearish -133 BCF Withdrawal In Today's Storage Report; EIA Announces Third Straight Crude Oil Inventory Withdrawal, But Oil Price Driven By Federal Reserve Shenanigans

6:00 AM EDT, Thursday, December 20, 2018
Volatile trading continued in the natural gas sector on Wednesday as the commodity retreated sharply from Tuesday's gains, falling 10 cents or 2.9% to $3.73/MMBTU. The close was actually something of a victory for the bulls as gas finished well off its lows of the day, having dropped to under $3.58/MMBTU early in the session. It is a bit unclear what drove Wednesday's initial sell-off as forecasts didn't abruptly trend warmer overnight Tuesday. Most likely, it was an acknowledgement by investors that Tuesday's 8% move higher was an overreaction and also by concern that the reliable ECMWF model at that point had not participated in the cooling trend to the extent that the GFS had. Throughout the day Wednesday, however, both near-term models trended colder still, the GFS again greater than the ECMWF, as shown in the Figure to the right. This prompted Wednesday's mid-session rally and cut losses to just 2.9%. However, the 00Z runs of both the GFS and ECMWF both trended considerably warmer which leaves investors in a bit quandary. Setting the up-and-down temperature outlook aside for a moment, on the one hand, heading into the last few days of December and the beginning of 2019, inventories likely will still be at or just under -600 BCF lower than the 5-year average with two potential arctic outbreaks on the docket, one to end the year and a second, per the CFSv2 and ECMWF-EPS long-term models in the middle of next month, not to mention another full 3 months of the cooling season still to go. Additionally, natural gas production growth has shown signs of slowing and, with yesterday's pullback, the commodity is now undervalued by at least 5% through the rest of the winter according to my Fair Price Model, even with the expected contraction in the storage deficit. On the other hand, however, momentum remains with the bears and, per last week's CFTC-reported money manager positions, there remains a lot of selling yet to be done to return to the 52-week average long/short balance. At this time, I feel that with the overnight warming in the computer models, the probability of near-term downside is greater than upside, but the magnitude of upside should the models trend back colder is greater than the magnitude of any downside. However, my near-term upside price target is a rather conservative $4.00/MMBTU though, should a true January arctic outbreak verify, $4.25/MMBTU would be achievable. However, with the large cut in the storage deficit expected in the next 10 days, I do not foresee prices returning to their November and December highs. I expect natural gas to maintain a price floor near $3.50/MMBTU. Both bulls and bears will get an important data point this evening when the twice-weekly 44-day ECMWF-EPS model comes out. This model trended sharply colder in its Monday evening run, helping to catalyze Tuesday's 8% rally. I expect there are many investors on the fence looking for follow-through or a reversal in this model before committing long or short. Click HERE to track the evolution of the near- and long-term computer model forecasts on my Advanced Models Page.

In its weekly Petroleum Status Report for December 8-14, the EIA announced Wednesday morning that crude oil inventories fell by -0.5 MMbbls. This was right at the 5-year average -0.6 MMbbl draw but was considerably better than the American Petroleum Institute's (API's) Tuesday forecast of a +3.5 MMbbl build. Despite the uproar in the crude oil sector regarding an impending oversupply, this was actually the third straight weekly inventory withdrawal, although two of those three were rather weak, under -2 MMbbls. Regardless, with the reported draw, inventories fell to 441.5 MMbbls while the storage surplus versus the 5-year average held flat at +27.5 MMbbls. However, thanks to last year's -6.5 MMbbl draw, the long-standing year-over-year deficit finally flipped to a storage surplus at +5.0 MMbbls. There was no significantly bullish or bearish supply or demand number responsible for the surprise draw. On the demand side, refinery inputs were flat week-over-week at 17.41 MMbbls/day (up +0.350 MMbbls/day year-over-year) while exports inched higher to 2.33 MMbbls/day (up 0.47 MMbbls/day year-over-year). All-told, total crude oil demand is up 0.81 MMbbls/day year-over-year, as shown in the Figure to the right. On the supply side, imports rose 30,000 barrels/day week-over-week, but are down 0.41 MMbbls year-over-year. All of these components of supply and demand go towards countering rapid growth in production which, while flat last week at 11.6 MMbbls, is still up 1.81 MMbbls/day year-over-year.

Helping the bulls out, the EIA announced that distillate inventories fell by a bullish and larger-than-expected -4.2 MMbbls to 119.9 MMbbls. This puts distillate stocks at a robust 14.3 MMbbl deficit versus the 5-year average and 8.9 MMbbls lower than last year. Gasoline inventories, meanwhile, rose +1.8 MMbbls in-line with expectations and are at a small 6.2 MMbbl storage surplus versus the 5-year aveage.

Click HERE for more on crude oil inventory, supply, and demand data and HERE for more on gasoline and distillate stocks.

For the most part, crude oil investors ignored Wednesday's overall lukewarm report with trading dictated on oversold technicals and the Federal Reserve messing with interest rates. After Tuesday's 7% swandive to a new 16-month low, WTI oil gapped up over 2% on Wednesday and steadily rallied throughout the day, before and following the EIA's Status Report, topping $48/barrel, up nearly 4%. The commodity swung violently between $48/barrel and $47/barrel immediately following the Federal Reserve's quarter-point rate hike and ultimately closed at $47.20/barrel, up 2.1% on the day. While I do not feel that Wednesday's inventory draw was a sufficient catalyst to drive oil sustainably higher, I do feel that it takes some selling pressure off the sector. And with OPEC's pledged production cuts scheduled to come into effect in the next 2 weeks, I expect oil to start establishing a bottom and attempting to make a move over $50/barrel. I feel that any price under $45/barrel represents a good opportunity to initiate a long-term long position. Ultimately, my 2019 WTI price target is $60/barrel, but the sector has considerable work to do before then.

My Oil & Natural Gas Portfolio took advantage of the rebound in oil prices to gap higher Monday and finished up +1.3%, pushing 2018 year-to-date returns to +2.4%. The Portfolio also benefited from my decision to re-enter the natural long trade on the morning's break below $3.60/MMBTU. I sold short a 4.1% position in DGAZ which, with the subsequent rebound in prices, now stands up +7.7% from my basis. This is the second time this week I have set up this trade, having covered on Tuesday morning for a quick 15% return. At this time, I am maintaining a $4.00/MMBTU price target on the trade and will likely hold a bit longer than my previous effort. As I discussed in yesterday's commentary, the 3X leveraged ETFs have woefully underperformed due to volatility-enhanced leverage-induced decay and I am content to let this run its course. Should the models trend warmer and natural gas pullback, my next threshold to add to this trade would be around $3.50/MMBTU. Regarding crude oil, with Wednesday's bounce, my net long exposure via short DWT is back under my safety margin of 10% at 8.5% of my holdings (a portion of the DWT short goes towards countering my BNO short as part of a Brent-WTI spread trade). Should oil pull back, rather than cut my position size (again) to stay below this threshold, I will consider transferring a portion of these holdings from short DWT to long UWT, as I did last month with natural gas, reducing the risk profile of a short 3X leveraged position while maintaining position size, at the expense of reducing profiting on leverage-induced decay. My long-term WTI price target remains $60/barrel. Click HERE for more on my current oil and natural gas holdings.

The EIA will release its weekly Natural Gas Storage Report for December 8-14 this morning at 10:30 AM EDT. I am projecting a -133 BCF natural gas storage withdrawal for the week. On the one hand, this would be the largest weekly draw so far this season. However, it would still be 11 BCF bearish versus the 5-year average and 32 BCF smaller than last year's draw. As the Figure to the right shows, it would be the third smallest draw in the last 5 years, less than half the 5-year high of -270 BCF, one of the largest draws on record, from back in 2013. Should a -133 BCF withdrawal verify, natural gas inventories would fall to 2781 BCF while the storage deficit versus the 5-year average will contract for a second straight week, sliding to -712 BCF. The year-over-year deficit, meanwhile, will tumble to -689 BCF. Click HERE for more on this week's projected draw.

Once again, I expect that investor response to this week's storage report to be a less important a driver to today's price movements than oscillations in the near-term computer models, unless the reported draw is dramatically larger or smaller than expected. I feel that a reported withdrawal of larger than -140 BCF, while still slightly bearish versus the 5-year average, will be viewed as unequivocally bullish and consistent with a tighter-than-expected supply/demand balance and could fuel a near-term run back above $3.80/MMTBU. On the other hand, a reported draw under -125 BCF would be a disappointment and could fuel a pullback back to under $3.60/MMBTU for the third time this week. A withdrawal between -125 BCF and -140 BCF would be neutral versus expectations with natural gas prices equally likely to rally or pullback.

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 second straight day today as much warmer temperatures overspread the major population centers of the Northeast. Forecast highs across this region will rise another 5F-10F day-over-day today with Washington, DC and Philadelphia both reaching the lower 50s and New York City and Boston the upper 40s, each nearly 10F warmer-than-normal. Elsewhere, as the Figure to the right shows, effectively the entire Lower 48 will be well above-average. Picking a few spots, Chicago will reach the upper 40s (normal: 33F), Detroit the upper 40s (normal: 34F), Oklahoma City the mid-50s (normal: 49F) and San Antonio the upper 60s (normal: 62F). As a result of the warm-up across the Northeast, today's forecast mean population-weighted nationwide temperature will rise 2.7F from Wednesday to 48.9F, a massive 8.5F warmer-than-normal. Forecast Total Degree Days will tumble to just 16.1 TDDs today, 9.2 TDDs fewer than normal and the single fewest for December 21 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 bearish -6 BCF/day daily natural gas storage withdrawal. This is down 3 BCF from Monday and nearly 12 BCF/day smaller than the 5-year average -17 BCF/day draw. By this evening, projected Realtime natural gas inventories will be near 2735 BCF while the storage deficit versus the 5-year average will be at -655 BCF, the lowest since November 12. Click HERE for more on today's projected daily withdrawal and Realtime natural gas inventories. Gas demand will hold roughly steady on Friday with another -6 BCF/day daily draw expected, pushing the total projected storage withdrawal for December 15-21 to just -51 BCF, a massive 70 BCF bearish versus the 5-year average. Things don't get much better the following week with an early -61 BCF withdrawal expected, another 46 BCF bearish versus the 5-year average. It would also take the year-over-year storage deficit under -500 BCF. I will have much more on these projections in Friday's commentary, but in the meantime see more on my Near-Term Natural Gas Storage Page HERE.