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October 3, 2018

Home --> Daily Commentary & Archive --> October 3, 2018 Daily Commentary


Natural Gas Rumbles Higher As "Fear Trade" Stays On; EIA Forecast To Announce Second Straight Crude Oil Inventory Build Today For The First Time Since April; Summer-Like Warmth Across The East Today To Drive One Of The Most Unseasonable Days Of The Year


6:00 AM EDT, Wednesday, October 3, 2018
Natural gas kept its hot streak rolling on Tuesday, rising another 7 cents or 2.3% to settle at $3.17/MMBTU, a new 9-month high. The rally was driven by expectations for a mid-October cooldown in the computer models in which a highly amplified pattern favoring a chilly Plains and Rockies but a mild East shifted slightly eastward potentially allowing cold air and heating demand to eventually more directly impact the larger population centers east of the Mississippi River. At this time, the focus of investors has swung dramatically from an emphasis on record production to inventories at a decade-low and the threat for arctic intrusions and the resultant spike in heating demand. The fact that both production and demand have seen dramatic--upwards of 15%--year-over-year gains means that natural gas volatility will likely increase this winter. Should temperatures drop, the spike in heating demand will be concomitantly higher than a year ago, quickly overwhelming strong supply and leading to a magnified withdrawal. Likewise, should a milder pattern set up, natural gas demand will plummet, allowing record production levels to be unopposed, leading to exaggeratedly weak draws. For this reason, I expect to see significant swings in prices from one computer model run to another. This will make for a challenging trading environment, but a potentially lucrative one for the nimble swing trader or the trader capitalizing on the leverage-induced decay of 3X ETFs, such as yours truly, which will be enhanced by rising volatility.


With Tuesday's rally, November 2018 front-month natural gas prices are now a strong 7.7% higher than a year ago, as shown in the Figure to the right, after spending nearly the entire summer at a considerable discount. Investors are finally pricing in the impact of 10-year low inventories. Eventually, this could lead to some demand destruction as well as upward pressure on more economically viable production, but for now, with 5-year high nuclear outages, demand remains historically strong for early October. For the first time since last spring, 5 consecutive Futures contracts are priced above $3.00/MMBTU, the November-March set. With current model runs continuing to show above-average cooling degree days across the South this week followed quickly by above-average heating degree days across the Plains and Midwest by late next week, the near-term path of least resistance continues to be higher. I would not be surprised to see natural gas top $3.20/MMBTU or even $3.25/MMBTU, particularly if the EIA reports a sub-90 BCF storage injection in Thursday's report. However, the higher that prices climb, the more attractive a longer term short the commodity becomes. If an when computer models trend back milder, investors will be quick to take profits and scramble away from the bullish trade. Additionally, more near term, when nuclear reactor outages begin to decline and when production tops 85 BCF/day, I would not be surprised bearish investors to jump on these negative catalysts and prompt lower prices. Given the current positive momentum and favorable temperature outlook, I am raising my price target to $3.25/MMBTU, but argue that such prices are unsustainable and anything over $3.20/MMBTU is a solid entry point for a short sale.


Ahead of today's EIA Petroleum Status Report, WTI pulled back slightly, falling just 7 cents or less than 0.1% to settle at $75.23/barrel after reaching a new 4-year high yesterday. Brent fell a slightly steeper 18 cents to $84.80/barrel. I maintain a $77/barrel price target on WTI, but am neutral to slightly bearish on Brent.


My Oil & Natural Gas Portfolio pulled back from Monday's all-time high, falling -0.5% on Tuesday and reducing 2018 gains to +20.8%. The portfolio was weighed down by gains in natural gas as the fund is now net short a 9.0% stake in the commodity. A 19.1% short UGAZ position, down -15.6% from my basis, is partially offset by a 10.1% short DGAZ position, up +31.9%, the largest gain in my portfolio. As discussed previously, by holding partially offsetting short positions of 3x natural gas ETFs, I can gain directional exposure (short, in this case), while at the same time boosting my total 3x ETF exposure so as to take advantage of leverage-induced decay without overexposing the portfolio in one direction. While I regret missing the second half of the run higher in natural gas prices this week, my trading strategy is unchanged. I will continue holding my current UGAZ and DGAZ positions, allowing leverage-induced decay to work its magic should natural gas chop around between $3.00/MMBTU and $3.20/MMBTU. Should prices top $3.20/MMBTU, I will likely add to my UGAZ short position, boosting my net short position to around 15% of my holdings. Should the forecast of a warmer-than-normal November and December come to fruition, my 2018 downside price target would be $2.90/MMBTU. My revised price target for WTI is now $77/barrel, though should today's EIA petroleum status numbers miss, I will consider taking profits on my net short DWT position--which stand at +31.8%--over $75/barrel. Finally, I will continue to hold my WTI-Brent arbitrage trade via short BNO and short DWT with a target WTI-Brent spread of $5/barrel with the potential to increase the position size should the spread top $10/barrel. Click HERE for more on my current oil and natural gas holdings.


The EIA will release its weekly Petroleum Status Report today at 10:30 AM EDT for the week of September 22-28, detailing oil and refined product inventory changes and supply and demand data. After Tuesday's close, the American Petroleum Institute (API) announced that it was forecasting a +0.9 MMbbl inventory build. Such a build would be slightly bearish versus the 5-year average -0.2 MMbbl draw, but quite bearish versus last year's 5-year high -6.0 MMbbl drawdown. As the Figure to the right shows, it would be the third largest build in the last 5 years, ahead only of 2013's +5.5 MMbbl and 2016's +3.6 MMbbl builds. It would be the first back-to-back weekly inventory build after last week's +1.9 MMbbl injection since the 2-week period ending April 28. Should a +0.9 MMbbl build verify, oil inventories would rise to 396.9 MMbbls while the storage deficit versus the 5-year average would narrow by around 1 MMbbl to -7.1 MMbbls. The year-over-year deficit would contract more sharply to -68.9 MMbbls. Once again, with exports likely to hold above 2 MMbbls/day thanks to a Brent-WTI spread averaging over $9/barrel throughout the week, I would not be surprised to see a smaller-than-expected build or even a small draw. However, should the EIA-reported number come in near or above the slightly bearish API forecast, I would expect the miss to provide investors an excuse to take profits and for WTI to pull back following the recent rally.


Check back at 10:30 AM EDT for the actual EIA storage numbers as well as refined product inventories and supply/demand data.


Natural gas demand will hold steady today with a projected daily storage injection that is very close to the 5-year average as unseasonably mild temperatures dominate the eastern two thirds of the nation. The largest anomalies will be found across the central Plains with Kansas City, St Louis, Omaha, and Topeka all approaching 90F, each more typical of early August and around 20F above-average. Further east, the major cities of the I-95 corridor from Washington, DC to New York City will all reach the low-80s, 10F-15F warmer than normal. This will drive elevated powerburn across a wide area. Below-average temperatures will be restricted to the far northern Plains and Rockies where highs may not get out of the mid-30s, up to 25F below-average. Across northern Montana and northwestern North Dakota, a period of wet snow is likely this morning that could add up to 1-2 inches, even at the lowest elevations. Overall, thanks to the warm-up across the East, the forecast mean population-weighted nationwide temperature today will warm by 1.3F day-over-day to 73.5F, a massive 8.9F warmer-than-average, among the largest nationwide anomalies this year. Total Degree Days will rise to 10.1 TDDs, the third most for October 3 in the last 38 years. Click HERE for more on today's temperature and degree day outlook. Despite the unseasonable warmth and anomalously large number of total degree days, based on this forecast and early-cycle pipeline data, I am projecting a +13 BCF/day daily storage injection, unchanged from yesterday and right at the 5-year average. By this evening, projected Realtime natural gas inventories will top 2920 BCF while the storage deficit versus the 5-year average will hold steady near -615 BCF. Click HERE for more on today's projected daily natural gas storage injection and Realtime natural gas inventories.