January 23, 2019

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Bearish Sentiment Engulfs Natural Gas In Second Worst Trading Day Of The 2010s After Temperature Outlook Moderates; Natural Gas Now Steeply Undervalued Across All Timeframes, But Beware The Falling Knife; Year-Over-Year Storage Surplus Projected To Flip Back To A Deficit Today After Only A 6-Day Stint

6:00 AM EDT, Wednesday, January 23, 2019
It was a brutal return to trading after a 3-day weekend for natural gas bulls as the commodity started the week by walking off a cliff. The February 2019 contract plunged 44 cents or 12.5% to settle at $3.04/MMBTU, its largest single-session slump since November 15. As the Figure to the right shows, it was the second largest slide since 2010 on a percentage basis, behind only that November sell-off, and was the 17th largest one-day drop all-time. The sell-off pushed the commodity to its lowest level since January 10 and it is now trading at a whopping 15.5% discount versus year-ago prices, despite storage levels being effectively identical year-over-year. The March 2019 contract, which will become the front-month contract next week once February 2019 expires, dropped 20 cents or 6.3% to settle at $2.97/MMBTU.

As it has been all winter, the driving force for Tuesday's sell-off was a warming trend in the near-term computer models. Over the weekend, both the ECMWF ENS and the GFS 14-day total gas-weighted degree day (GWDD) outlooks have steadily declined by 10%-20% as shown in the Figure to the right. Both remain above historical normals, although the 12Z GFS run from yesterday came in quite close to this threshold. While both models continue to show two significant arctic outbreaks between now and February 5, the models are trending towards a more progressive pattern, quickly scouring this arctic air and favoring a return to milder conditions by the second week of February rather than a continuation of sustained below-average temperatures. This is further supported by both long-term models, the ECMWF-EPS and CFSv2, which develop some modest ridging across the Central and Eastern US by this time allowing more sustained warmth to move northward. Because natural gas investors are a forward-looking bunch, the upcoming brutally cold air is neglected in favor of this warming trend in the 12-20 day time frame, resulting in the rapid sell-off seen Monday. It is worth noting, however, that both the CFSv2 and ECMWF-EPS are suggesting that this warmth will be short-lived with a return to troughing and much colder temperatures across the East by the February 15-25 period. Click HERE for more on the near- and long-term temperature outlook and model trend on my Advanced Model Page.

With Monday's sell-off, the February 2019 contract is the only natural gas contract for the next 8 months that is trading above $3.00/MMBTU. As a result, the commodity is trading at a large undervaluation across all time frames. Based on current Realtime inventories alone and a storage deficit versus the 5-year average of -385 BCF, the commodity is undervalued by 20% against its Fair Price of $3.85/MMBTU, according to my Fair Price Model. With arctic air expected to drive this storage deficit towards -475 BCF and the February contract slated to expire in backwardation, this undervaluation rises to 26% by February 8 as my projected Fair Price rises to $4.08/MMBTU. Even thereafter, assuming normal temperatures and a loose natural gas supply/demand balance, the commodity is averaging an 18% undervaluation over the next 8 months through August as Futures prices hold under $3.00/MMBTU. Click HERE for more on natural gas futures and my Fair Price model. What does this mean for natural gas? Despite the negative sentiment that comes with the moderating temperature outlook, I feel that yesterday's sell-off took most of the bearish pressure off natural gas. While such large undervaluations do not necessarily mandate a sustained rally and it is highly unlikely that natural gas tops $4.00/MMBTU again this winter, I feel that potential upside outweighs downside risk at these levels. My price target for the March contract before its expiration 5 weeks from now is $3.40/MMBTU, representing 15% upside from current levels. Moving forward, what will dictate price movements will be the duration of the upcoming warm-up and then magnitude of the subsequent cooldown, if it happens. Stay tuned.

Meanwhile, crude oil slid on Tuesday as bearish economic data out of China over the weekend weighed on sentiment. However, prices finished well off their lows after the EIA announced that it expected domestic output to slow in February to just a gain of 62,000 barrels/day. WTI dropped $1.23 or 2.3% to close at $52.57/barrel after dropping to $51.80/barrel early, while Brent settled down 2.0% to $61.50/barrel. The February 2019 WTI contract expired at the close of trading Tuesday and will be replaced as the Front-Month contract today by the March 2019 contract which closed at $53.01/barrel. The EIA's weekly Petroleum Status Report will be delayed until Thursday due to the Martin Luther King holiday while API data will be released after today's close. At this time, I feel that oil prices could be set up for more near-term downside, especially if tomorrow's EIA data disappoints, and I am targeting a pullback target of $50/barrel. However, the EIA's forecast of slowed production growth in February is likely a sign of things to come and I am maintaining a $60/barrel 2019 price target on the commodity.

Thanks to the sell-off in natural gas prices on Tuesday, my Oil & Natural Gas Portfolio saw its worst day of 2019 to-date, slumping -1.7% on the session. This reduced year-to-date gains to +6.5%, or +118% annualized. However, the losses were somewhat blunted by my new short position in WTI via short UWT, which stands at 3.8% of my holdings and is up +4.9% from my basis. At this time, I am holding this short with a target WTI price target of $50/barrel. With Tuesday's losses, my natural gas long exposure has risen to a net 10.3% with a 13.5% DGAZ short position countering a -3.2% short position for total 10.5% net long exposure. Tuesday's losses were also exacerbated by weak equity markets and my long positions in LNG (-2.8), GLNG (-5.0%), and SWN (-7.0%).

Regarding my natural gas position, while I am concerned about the negative sentiment engulfing the commodity, I plan to continue holding at this time as I believe upside potential outweighs downside risk. In yesterday's commentary, I had discussed adding to my long position should the March 2019 contract fall under $3.00/MMBTU. In the end, I was reluctant to do so given the swiftness of the sell-off, the potential for further follow-through in the days to come, and my oversized position size and so deferred. Should prices hold under $3.00/MMBTU and the near- or extended-term outlook trend more supportive, I will consider doing so. More than anything, however, I am encouraged by the recent spike in volatility. As the Figure to the right shows, daily natural gas volatility has averaged +/-4.3% per day over the past 10 days, more than double from a week ago and the highest since late December. It is also nearly double last year's volatility, which was around +/-2.4% per day. This volatility will act as a significant tailwind for my short 3X ETF position for the next month as it will fuel leverage-induced decay. Even should natural gas not see a sustained bounce, the position will likely turn a profit should natural gas chop around with such large daily moves. For this reason, I plan to continue to hold and will make only small adjustments to mitigate risk in the event of worsening fundamentals or add to my position should Mother Nature cooperate.

Natural gas demand will bottom for the foreseeable future today as unseasonably mild temperatures rapidly overspread the Northeast ahead of the next wave of arctic air. Highs will rise to near 50F in Washington, DC, the mid-to-upper 40s in Philadelphia and New York City, and the low 40s in Boston, all 5F-10F warmer-than-normal. Across the interior Northeast--including areas that received 1-2 feet of snow over the weekend--the anomalies will be even larger with Buffalo reaching the mid 40s and Pittsburgh the low 50s, 15F-20F warmer-than-normal. Across the Great Plains and Midwest, a modest area of low pressure will bring 6-10 inches of snow to Madison, WI and the suburbs of Milwaukee while Chicago will receive a wintry mix. Behind this system, temperatures will be 5F-15F colder-than-normal, including in Minneapolis (18F) southward to St Louis (33F) and Houston (50F). However, the rapid warming across the more populous East will drive the weather pattern today. As a result, today's forecast mean population-weighted nationwide temperature will soar 6.0F from Tuesday to 42.9F, 3.6F warmer-than-normal. Forecast Total Degree Days (TDDs) will fall to 21.7 TDDs, 4.5 TDDs fewer than normal and the 13th fewest 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 -18 BCF/day daily natural gas storage withdrawal for today, 11 BCF smaller than yesterday's draw and 3 BCF bearish versus the 5-year average -21 BCF/day. By tonight, I project that Realtime natural gas inventories will have fallen to near 2240 BCF while the storage deficit versus the 5-year average will have contracted slightly to -325 BCF. However, the draw will still be 4 BCF larger than last year's and, as a result, by late this evening I project that the year-over-year surplus will flip back to a tiny -1 BCF deficit, a mere 6 days after it had come into being. Click HERE for more on today's projected daily storage withdrawal and Realtime natural gas inventories. Natural gas demand will rebound to near-average levels tomorrow as arctic air moves into the Plains and Midwest before surging on Friday as it presses east.