January 22, 2019

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Sell-The-News Edition: Natural Gas Gives Up Friday's Gains & Then Some In Holiday Trade As Investors Respond To Near-Term Model Moderating Trend; Natural Gas Undervaluation Rises As Long-Term February Outlook Remains Consistently Colder-Than-Normal; Gas Demand To Drop Today Ahead Of The Next Wave Of Arctic Air

6:00 AM EDT, Tuesday, January 22, 2019
US markets may have been closed for the Martin Luther King Holiday on Monday, but that didn't mean there wasn't action aplenty in the natural gas sector. Electronic futures trading effectively erased last Friday's sharp, late-session rally, sending prices tumbling 7% to end the abbreviated session at $3.24/MMBTU, near Friday morning's lows. Because there was no floor trading, there was no official settlement for futures contracts. In the same way that Friday's rally was driven by an abrupt cooling in the GFS and ECMWF models, Monday's sell-off was due to a steady warming trend in these models over the weekend. Rather than prolonged arctic outbreaks that spread all the way south to the Gulf of Mexico, the current thinking, especially by the GFS, is that there will be plenty of arctic air available but that it won't penetrate into the Deep South and that it won't stick around across the Lower 48. This was the sentiment that was picked up by the Bears and they executed their revenge on bulls that bought into the rumor of cold air on Friday (including yours truly) in classic sell-the-news fashion. However, the problem is in this argument is that the GFS model runs that the bears seem to be hanging their caps on doesn't have that much support, even by its own ensembles. The overall pattern with a blocking Greenland High and a northeast Pacific ridge remains in place. And in particular, the ECMWF has held firm in its forecast and is indicating a potential epic onslaught of arctic air from the northern Plains all the way to south Florida for the January 28-February 1 period that could drive daily storage withdrawals above -50 BCF. Additionally, the 00Z run of the GFS also trended colder and hinted at a major arctic outbreak during this period as well, although the arctic air does not extend as far south as its European counterpart. The Figure to the right plots the 14-day total forecast Gas-Weighted Degree Day (GWDD) trend for the GFS and ECMWF ENS over the past week showing Friday's spike and then the weekend warming trend. The late-Monday cooling trend in both models is deceptively blunted as this new 14-day period did not include yesterday's much above-average GWDDs as earlier runs did.

Additionally, Monday evening saw the release of the twice-weekly ECMWF-EPS long-term model, perhaps the crown jewel in my Hybride model that also integrates data from the long-term CFSv2 model and the short-term GFS & ECMWF ENS. Near-term, the ECWMF-EPS favors a brutally cold stretch for the last few days of January and first of February, supporting the short term models. Thereafter, the ECMWF-EPS and CFSv2 are in quite good agreement on a warming trend back to near or slightly above-average for the second full week of February followed by another shot of arctic air peaking around February 1. As the Figure to the right, which plots daily forecast departure from normal daily GWDDs for the next 44 days, shows, my Hybrid Model is forecasting above-average GWDDs each day through this period. Click HERE for more on the near- and long-term computer model trends.

Given the persistent ECMWF, overnight cooling of the GFS, and overall favorable long-term ECWF-EPS, natural gas cut into its losses in overnight futures trade, rebounding to as high as $3.35/MMBTU, before falling back under $3.30/MMBTU after the 00Z ECMWF disappointed, right around the time of publication of this commentary. Despite the weekend moderation, I still feel that Monday's selling was overdone. Even based on the realtime natural gas storage deficit versus the 5-year average--which is two days removed from a near-term minimum--natural gas is trading at a 13% undervaluation versus its Fair Price of $3.84/MMBTU. Based on my current projections, which still includes a blunted arctic outbreak for the last few days of January due to the weighting of the GFS in my projection model, which could drive draws even higher than currently forecast if the GFS falls into line with the ECMWF, this Fair Price rises to $4.02/MMBTU, a 23% undervaluation once the front-month contract roles over into the March 2019 contract. My near-term price target for the February 2019 contract is $3.75/MMBTU and $3.50/MMBTU for the March 2019 contract, which is currently held by natural gas ETFs. I feel an entrypoint under $3.10/MMBTU--or, more ideally, $3.00/MMBTU--for the March contract is attractive for a long-term hold.

Meanwhile, WTI crude oil soared $1.73 or 3.3% on Friday to settle at $53.80/barrel while Brent rose 2.5% to $62.70/barrel. On the week, WTI rallied 4.3% while Brent was up a comparable 3.7%. The most-active March 2019 contract, which will become the front-month contract at the close of trading today, closed Friday at $54.04/barrel. Friday's rally was bolstered initially by ongoing optimism regarding a thawing of US-China relations and was then jolted higher after Baker Hughes reported that the Rig Count tumbled by 21 rigs last week to 852 rigs, the third straight decline and the largest weekly drop in almost 3 years. Despite these bullish signals, I remain somewhat skeptical of the near-term sustainability of WTI prices above $54/barrel as the US storage surplus and domestic production continue to grow. Yesterday and overnight, oil volatility was low, but as worldwide markets softened on fears of bearish Chinese economic data, WTI prices fell with the March 2019 contract sliding 1% to $53.50/barrel. At this time, I am favoring a pullback towards $50/barrel, especially if US equities markets weaken. Long-term, I still expect a tightening of supply/demand balance and am maintaining a $60/barrel 2019 price target.

On Friday, my Oil & Natural Gas Portfolio rose +0.7% to head into the 3-day weekend on a strong note and to drive weekly gains to a strong +2.1%, the third straight weekly gain to start off 2019. Year-to-date gains stand at +8.4% or a very early +151.5% annualized. It was a busy week last week as I made a total of 6 trades, most of which involved swinging in and out of natural gas. On Monday, I flipped from long to short natural gas on the price spike, only to flip back to net long the following day. In doing so, I restored one of my favorite set-ups: the short 3X ETF pair trade. To do this, I shorted a large 10% stake short DGAZ while also continuing to hold a 4% stake short UGAZ. I established this pair trade rather than just covering UGAZ and shorting a ~6% position in DGAZ because it allows me to boost total 3X ETF exposure without increasing net directional exposure. With 10-day average volatility rising back above +/-3% per day with the recent price spike, leverage-induced decay will likely be exaggerated over the next few weeks as natural gas tries to find a trading range. If anybody has any questions on this pair trade and why I employ it, please send my an email (CelsiusEnergyFM@gmail.com) or send my a DM on twitter. On Friday, I became perhaps a bit too trigger happy in response to the brutally cold ECMWF model run and shorted an additional 2% position in DGAZ to boost net long exposure. As it stands right now, my short DGAZ position stands at 11.4% of my holdings while my UGAZ short is worth 3.9%, meaning that the portfolio is net long 7.5%. At this time, I have no intention to bail on this trade on what looks to be a bearish open on Tuesday. Rather, should the March 2019 contract held by the ETFs fall under $3.10/MMBTU and the temperature outlook remain favorable, I will consider adding to my long position and if it falls under $3.00/MMBTU, I definitely will. My maximum tolerable net long exposure for the trade is 12% of my holdings. On Friday, I additionally made the decision to flip from a net long to a net short position in WTI once the March 2019 contract topped $54/barrel. Thus, I covered my short DWT stake and shorted a 4.0% UWT position. This is intended as a swing trade only and my price target is $50/barrel, at which point I will likely flip back to net long. Click HERE for more on my current oil and natural gas holdings.

After the first arctic blast of 2019 peaked yesterday with an exceptionally bullish -45 BCF/day daily storage withdrawal, I project that natural gas demand will begin a rapid, but temporary, descent today as temperatures moderate. It will be another brutally cold morning across the Northeast and Mid-Atlantic this morning with Pittsburgh falling to around 2F, New York City to 10F, and Boston to 5F, 15F-20F colder-than-normal. However, temperatures will warm 10F-20F from Monday by this afternoon with Philadelphia, New York City, and Boston all reaching the upper 20s while Washington, DC will likely break the freezing mark. However, these readings are still 5F-10F colder-than-normal. Further west, a modest storm system will bring light snow to Minneapolis, MN and Madison and Milwaukee in Wisconsin. In the southerly flow ahead of this system, temperatures will warm to 5F-15F warmer-than-normal across the lower Mississippi River Valley with Little Rock, AR reaching the upper 50s, Jackson, MS the lower 60s, and New Orleans, LA the lower 70s. Overall, thanks to the warming across the East, today's forecast mean population-weighted nationwide temperature will rise 5.9F from Monday to 36.9F, still 2.3F colder-than-normal. Likewise, Total Degree Days will tumble to 27.6 TDDs, just 1.3 TDDs greater than average and the 17th most for January 23 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 -29 BCF daily natural gas storage withdrawal, more than 15 BCF smaller than yesterday's draw but still 8 BCF bullish versus the 5-year average -21 BCF/day draw. By this evening, projected Realtime natural gas inventories will have fallen to 2260 BCF while the year-over-year surplus will drop to a mere +6 BCF after peaking near +40 BCF on Friday. This surplus will likely flip to a deficit tomorrow. Click HERE for more on today's projected daily storage withdrawal and Realtime natural gas inventories.

Looking ahead, natural gas demand will be highly volatile through the first week of February with a highly amplified pattern driving multiple waves of arctic air southward, no matter how the forecast actually pans out. Gas demand will likely bottom out on Wednesday with a projected daily draw that is just below the 5-year average. A reinforcing shot will then race eastward across the Northern Plains and into the Northeast with demand falling to near -40 BCF/day by Friday and Saturday. After a small moderation, demand will likely rebound again with perhaps the biggest arctic shot yet driving daily withdrawals as high as -45-50 BCF/day by January 30, as shown in the Figure to the right that plots daily storage withdrawals for the next 14 days. While demand may fade thereafter, as mentioned earlier, both the ECMWF-EPS and the CFSv2 models keep generally below-average temperatures in place through the remainder of February. At this time, through the week ending February 8, I am projecting that natural gas inventories will fall to near 1765 BCF while the storage deficit versus the 5-year average will rise to -450 BCF, just under 300 BCF shy of the peak set -730 BCF set back in mid-November. As discussed above, this corresponds to a Fair Price of $4.02/MMBTU, a 23% undervaluation versus current prices. Click HERE for more on near-term natural gas storage projections.