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June 3, 2019

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Energy Sector Pummeled In Weekly Rout Sending Natural Gas Prices To A 3-Year Low & Oil To A 4-Month Low; Both Commodities Undervalued & Good Long-Term Buys--But That Doesn't Mean They've Bottomed; Realtime Natural Gas Inventories Top 2000 BCF As Daily Builds Remain Very Bearish Before Late-Week Recovery In Demand


6:00 AM EDT, Monday, June 3, 2019
Commodities continued their washout on Friday as relentless selling overwhelmed the entire energy sector. Natural gas slumped 9 cents or 3.7% to settle at $2.45/MMBTU, a 6% weekly loss and the lowest since June 3, 2016. It is worth pointing out that, at that point in 2016, were right at 3000 BCF, a massive 1000 BCF higher than current inventories, albeit the supply/demand balance had tightened up considerably at that point and the large storage deficit was in the process of contracting. Natural gas prices are down a steep 17.2% from 2018 when prices were trading at just under $3.00/MMBTU, as shown in the Figure to the right. As a result of the sell-off, natural gas volatility has risen, averaging +/-1.68% per day over the past 10 days, up 0.6% from last year. This is bad news for those investors holding long positions in UGAZ or DGAZ. With increased volatility--especially during what is historically a low-volatility season for the commodity--leverage-induced decay will be enhanced and these instruments will underperform. As I have discussed previously, it is for this reason that I almost exclusively trade these ETFs on the short side, short UGAZ to bet on downside and short DGAZ to bet on upside.


The pullback in natural gas prices may have been triggered by the EIA's announcement of a bearish and much larger-than-expected +114 BCF storage injection on Thursday, but the driving force behind the renewed downward momentum has been the imminent prospect of a sustained period of below-average temperatures throughout June, though some questions remain concerning the specifics of this cooldown. As the Figure to the right shows, there has been something of a divergence in the near-term GFS ENS and ECMWF ENS models with the GFS trending towards a warmer solution over the last 36 hours while the typically superior ECMWF has trended towards a much cooler outlook. However, this has more to do with variance in the 1-6 day period as both models are set on a period of below-normal temperatures in week 2. As its stands right now, this has resulted in my projected weekly storage injections rising with bearish triple digit builds expected through June 14th, driving the storage deficit versus the 5-year average under -200 BCF by that time. As a result of this bearish outlook and a continued loose temperature-independent supply/demand imbalance, my season-ending projected natural gas storage injection has risen to near 3855 BCF, more than 600 BCF higher than last year.


This is what has driven the sell-off.


Nonetheless, with prices falling to such low levels at a time when powerburn is just beginning to ramp up, I do expect to see some level of fuel-switching that could help to tighten the market, alongside another expected bump in LNG export demand as Cameron, Freeport, and Elba Island all ramp up. For this reason, I see limited further near-term downside risk--beyond the current steep discount--in the natural gas sector with an upside price target of near $2.60/MMBTU should June temperatures trend towards the GFS ENS solution. It is for this reason, early or not, I flipped from net short to net long natural gas on Friday. Click HERE for more on the temperature outlook on my Advanced Modeling Page and HERE for more on my long-term natural gas storage projections.


Meanwhile, crude oil somehow managed to have an even rougher week than natural gas. WTI plunged another $3.09 or 5.5% on Friday to $53.30/barrel, the lowest settlement since February 12. The commodity lost a massive 8.8% for the week and was down 16.3% during the month of May. Brent oil finished down $2.38 to $64.49/barrel, as the Brent-WTI price spread ballooned to a massive $11.19/barrel, which should in theory favor US exports. Like natural gas, the latest wave of this sell-off may have been driven by EIA storage data--in this case a much smaller-than-expected inventory draw--but the plunge was further exacerbated by ongoing geopolitical concerns as well as a sell-off in US equities. This all being said, I continue to feel that the sell-off has been overextended for several reasons. First, based on current inventories alone, oil is trading at a nearly 12% undervaluation from its Fair Price of $60.67/MMBTU according to my model, even with the recent series of bearish builds. And while, the current looseness in the market suggests that this undervaluation could flip to an overvaluation by the autumn, should refinery input demand rise to seasonal averages once the ongoing series of unexpected outages resolves. Additionally, the EIA has reported anomalously large Adjustment Factors--a "fudge factor" to match up storage data and supply/demand numbers--suggesting a significant underestimation of imports over overestimation of exports, most likely due to issues with import/export timing. These will likely resolve in the next several weeks and could result in a series of unexpectedly large inventory draws that could catch some short sellers unawares. For this reason, I am still holding to my 2019 WTI price target of $65/barrel and would be surprised to see the price point fall under $50/barrel.


Due to the sell-off in oil, my Oil & Natural Gas Portfolio had a disappointing week, sliding 2.4% in its largest 1-week loss since January. 2019 year-to-date gains now stand at +10.9%, or +24.4% annualized. I made a total of 3 trades on the week. First, when oil broke down under $57/barrel, I doubled my DWT short position--a long bed on oil--which now stands at a large 11.9% of my holdings. While I feel that oil is very cheap at current levels, my position size is already near my maximal tolerable risk and I will not be adding to my DWT short position further. Should prices fall under $52/barrel, I will consider initiating a lower-risk UWT long position, though I do not expect I will let total exposure rise much above 15% of my holdings. Additionally, on the Friday break under $2.50/MMBTU, I flipped promptly from net short to net long natural gas by taking profits on a portion of my UGAZ short position and transferring these to DGAZ short. Current net long exposure stands at a modest 5.5% with an 11.8% short DGAZ position partially offset by a 6.3% short UGAZ stake, so as to maximize leverage-induced decay. At this time, I will only consider adding to this position should the commodity drop under $2.40/MMBTU. While I feel that significant downside is limited, I do feel that the commodity will struggle to see a sustainable rally given the rather bearish June outlook. Rather, I expect to see rangebound trading in the $2.40/MMBTU to $2.50/MMBTU range until we see powerburn start to ramp up, which could support a rally to my upside target of $2.60/MMBTU. Click HERE for more on my current oil and natural gas holdings.


Over the weekend, natural gas demand fell to bearish levels as below-average temperatures dominated the Northeast and Desert Southwest. I project daily storage injections of +17 BCF on both Saturday and Sunday, nearly 4 BCF/day bearish versus the 5-year average. On Sunday afternoon, projected Realtime natural gas inventories topped 2000 BCF, 13 days ahead of 2018's pace. Natural gas demand will hold relatively steady today as the overall pattern remains entrenched. The Northeast and Ohio Valley will again be unseasonably chilly with Washington, DC and Philadelphia only reaching the mid-70s--5F-10F cooler-than-normal--while larger anomalies will be found inland with Pittsburgh and Detroit only reaching the mid-60s and Buffalo, NY struggling into the upper 50s, 10F-15F below-average. The Southwest will remain seasonally cool as well with Phoenix, AZ "only" reaching the low-to-mid 90s, around 5F cooler-than-normal. Hot spots across the nation will continue to be the Deep South with Jacksonville, FL reaching the upper 90s and Atlanta, GA near 90F, 5F-10F warmer-than-normal. Additionally, it will be hot across the northern Rockies and northern Plains with Billings, MT and Bismarck, ND approaching 90F, 10F-15F warmer-than-normal, though low population densities across this region will limit the impact of this heat on a nationwide basis. Overall, today's forecast mean population-weighted mean nationwide temperature will cool another 2.3F to 70.0F, 0.5F cooler-than-normal. Total Degree Days (TDDs) will only dip slightly to 7.9 TDDs, 0.5 TDDs fewer than normal and the 15th fewest for June 3 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 preliminary +17 BCF/day daily natural gas storage injection, up less than 1 BCF from Sunday and a bearish 4 BCF larger than the 5-year average +13 BCF/day daily build. By tonight, I project that Realtime natural gas inventories will rise to near 2028 BCF while the storage deficit versus the 5-year average will dip to near -237 BCF. Inventories will finish the day +185 BCF larger than a year ago. Click HERE for more on today's projected daily storage injection and Realtime natural gas inventories.


For the remainder of the week, gas demand looks to bottom for the week on Tuesday as below-average readings spread to Texas, the largest natural gas consuming state, with a +18 BCF/day daily injection. Thereafter, expect demand to steadily rise with warmer-than-normal readings overspreading the Eastern Seaboard and much of the Central US, driving cooling demand higher. As a result, daily injections could fall to around +14 BCF/day by the end of the week, or just above the 5-year average, as shown in the FIgure to the right. Overall, for the upcoming week of June 1-7, I am projecting a large +112 BCF natural gas storage injection, 20 BCF bearish versus the 5-year average. It would be the largest weekly build in the last 5 years for the June 1-7 period and the second largest all-time, behind 2003's +123 BCF injection. Click HERE for more on this week's projected storage injection. The EIA will release its official storage numbers for the week the following Thursday, June 13, at 10:30 AM EDT. The strong end of the upcoming week won't last, unfortunately for the bulls, with another wave of unseasonably chilly temperatures sweeping out of the Rockies by the beginning of next week.