December 27, 2018

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Crude Oil Surges Nearly 10% While Natural Gas Recovers From Steep Early-Session Losses As US Markets Rally Across The Board; Year-Over-Year Natural Gas Storage Deficit To Contract 5% In A Single Day Today As Spring-Like Eastern Warmth Crushes Demand; Oil & Natural Gas Portfolio Sees Largest Daily Gain In Over A Month

6:00 AM EDT, Thursday, December 27, 2018
Stomach-churning volatility continued the day after Christmas, but this time it brought with it a welcome respite for long-suffering oil traders. WTI crude oil saw its largest single-session gain since November 30, 2016 , rising a massive $4.69 or 8.6% to settle at $46.22/barrel. Despite Wednesday's surge, WTI prices are still down 9.3% on the month. Of note, crude oil ETFs seemed to significantly underperform on Wednesday with the 1X ETF USO rising "just" +6.6% and the 3X ETF UWT rising a "mere" +16.9% versus a predicted gain of +25.8%. This is due to the fact that equity markets closed at 1 PM on Monday while commodities trading closed at 1:30 PM and during that final 30 minutes oil tanked an additional 2%. This resulted in ETFs that appeared to outperform on Monday but underperform yesterday, but in the end tracked their underlying commodity reasonably well. With the rally, WTI oil shaved nearly a quarter off its nearly 30% undervaluation versus a Fair Price of $60.37, but is still undervalued by a robust 23% based on current domestic crude oil inventories. However, despite this ongoing undervaluation, I feel that oil will need at least a few days--and ideally some supportive data--to help digest these gains before the commodity makes any more headway towards $50/barrel. Yesterday's move was a purely oversold bounce (off, admittedly, an overextended and irrational move lower) and was not supported by news of production cuts or declining inventories. For this reason, I would not be surprised to see oil pull back some from here, particularly if US equities markets give back some of their gains too. I feel that a pullback under $45/barrel or so would be a reasonable opportunity to add to a long-term long position. The trading action on Monday and yesterday felt like a blow-off bottom and, barring a dramatic loosening of supply/demand balance, I do not expect oil to revisit this week's lows.

While not quite as vigorous as oil, natural gas staged its own rally on Wednesday, recovering from an early-morning swandive down nearly 5% to $3.30/MMBTU to finish the day up 7 cents or 2.2% to $3.54/MMBTU. Like oil, this was largely an oversold bounce due to technicals and a more than 20% undervaluation versus its Fair Price. However, the near-term computer models remain stubbornly divergent. The reliable ECMWF continues to forecast seasonally cool conditions for the next two weeks beginning this weekend, but even it is not forecasting a set-up that is favorable for sustained arctic cold across the US. The GFS, on the other hand, is much warmer with any intrusions of modified arctic air southward quickly expunged and providing minimal support to natural gas demand. The model trended steadily warmer throughout the day yesterday, before cooling somewhat for this morning's 00Z run, as shown in the Figure to the right. At this time, with the January and February 2019 contracts on either side of $3.50/MMBTU, I feel that the best place to be in the natural gas trade is minimally invested or even on the sidelines. Despite the mild temperatures and fading storage deficit, I do not want to be short here, with natural gas down more than 25% in two weeks, a large undervaluation versus its Fair Price, a -600 BCF storage deficit, and 3 months of winter to go as the chances of another price spike are very real. On the other hand, the GFS's very bearish near-term outlook cannot be ignored, especially in the setting of an excess of longs as reported by the CFTC sitting on large unrealized losses one bearish turn of the ECMWF away from throwing in the towel and selling. Should the GFS forecast verify, the natural gas storage deficit versus the 5-year average could very well drop under -500 BCF by the second week of January, down nearly 250 BCF in less than 6 weeks. The last time that the storage deficit was under -500 BCF was on July 2, at which time natural gas, though egregiously undervalued, was trading at $2.86/MMBTU. Additionally, after retreating last week, natural gas production has staged a rebound, again topping 88 BCF/day to start the week. For these reasons, I would feel much more comfortable starting or adding to a long position if natural gas prices were closer to $3.25/MMBTU than $3.50/MBTU. However, respecting the low inventories and the threat for another arctic outbreak this winter, I am maintaining a $4.00/MMBTU upside price target on the commodity.

Of note, because of the 1.5 day trading holiday, both the EIA's Natural Gas Storage Report and Petroleum Status Report will be delayed until this Friday, the former at 10:30 AM EDT and the latter at 11:00 AM EDT.

Thanks to surging equity, oil, and natural gas markets, my Oil & Natural Gas Portfolio saw its best day in over a month on Wednesday, surging 3.0% and finishing at session-highs. This was significant as it flipped what had turned into a small year-to-date loss back to a +2.5% year-to-date gain. Despite the huge day, I made no trades as all of my positions remained below my price targets or had rallied too much in too short of time to consider buying. Unsurprisingly, my biggest gains were my oil long positions with my 7.6% short DWT position returning +23.3% and my 7.2% long UWT stake rising +16.9%. These two holdings are nearly equal in size which means that my portfolio is insulated against leverage-induced decay compared to if I was just long UWT, but it also does not profit from it, as it would if I was just short DWT. My net long oil position stands at a moderate 8.2% with the remainder of my 14.8% total UWT + DWT holdings going towards offsetting my BNO short as part of a Brent-WTI spread trade. Each of my 3 equity positions--long LNG, GLNG, and SWN--were up at least 6% on Wednesday. The largest of these is Cheniere Energy (LNG) which is also my largest directional holding among either equities or ETFs. With Wednesday's 6.6% rally, the position is now worth a robust 10.1% of my holdings and, at $58.94/share, remains well under my conservative $75/share price target. This position will tend to do better should US natural gas prices fall further as this will increase the company's profit margin. It will likely be a long-term hold. Finally, natural gas ETFs actually fell on Wednesday despite the rally in natural gas thanks to the same issues that oil experienced on Monday related to the early market close, as discussed at the beginning of this commentary. Additionally, the February 2019 contract which is held by natural gas ETFs significantly underperformed the front-month January 2019 contract, finishing up less than 1%. My natural gas long exposure is limited and comes via a short 4.2% DGAZ position that is nearly flat versus my basis. As discussed above, I am not excited about adding to this position at current levels due to high uncertainty in the near-term computer models. However, with very high volatility, the 3X ETFs are almost certain to underperform due to leverage-induced decay so I am content to continue holding my small position, even if natural gas continues to fall as this short trade will profit from this decay. At this time, I will consider adding should February 2019 prices drop under $3.30/MMBTU, although I may raise this price point should computer models trend colder. My price target is $4.00/MMBTU. Click HERE for more on my current oil and natural gas holdings.

Natural gas demand will continue to slump today as springlike-warmth dominates the major population centers of the Northeast with highs 20F-30F warmer-than-normal. The driving force behind these anomalies is an unusually powerful Great Plains storm system that is bringing blizzard conditions to parts of the Dakotas and Minnesota and 12-18 inches of snow to areas like Fargo, ND. However, with the low pressure center tracking northward across Iowa and into Minnesota, a strong southerly flow ahead of and to the right of the storm will allow Gulf of Mexico air to surge as far north as the St Lawrence River Valley in Canada. Columbus, OH and Pittsburgh, PA could both reach 60F today, 25F warmer than normal. Richmond, VA could reach 70F while the Megalopolis will see highs from near 60F in Washington, DC to the mid-50s in New York City and near 50F in Boston, all around 20F warmer-than-normal. Below-average temperatures will be restricted to the western High Plains and Intermountain West with Bismarck, ND and Sioux Falls, SD struggling to reach double digits, 10F-15F colder-than-normal. However, these areas are sparsely populated compared to the balmy Eastern Seaboard. As a result, today's forecast mean population-weighted nationwide temperature today will rise 2.5F from Wednesday to 47.9F today, a massive 8.4F warmer-than-normal. Total Degree Days (TDDs) today will fall to a mere 15.9 TDDs, the second fewest for December 27 in the last 28 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 -5 BCF/day daily natural gas storage withdrawal, 3 BCF smaller than Wednesday and a massive 10 BCF bearish versus the 5-year average -15 BCF/day. By tonight, projected Realtime natural gas inventories will have dropped to around 2666 BCF while the storage deficit versus the 5-year average will fall to -614 BCF, the lowest since October 14. The year-over-year deficit, meanwhile, will tumble by 24 BCF to -518 BCF, a nearly 5% reduction in a single day. Click HERE for more on today's projected daily storage withdrawal and Realtime natural gas inventories.