January 3, 2019

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Natural Gas Opens The Year On A Sedate Note, But Mild Temperature Outlook And Absent Bullish Catalyst Overwhelm Large Fundamental Undervaluation; Crude Oil Rises But Gives Back Gains Overnight After Apple Earnings Miss; Gas Demand To Begin Weeklong Downturn Today As Temperatures Warm Across The Heartland

6:00 AM EDT, Thursday, January 3, 2019
Natural gas started 2019 off on a rather muted note after prices had tumbled 36% during December, the largest monthly decline in 15 years. February 2018 gas rose 2 cents or 0.6% to $2.96/MMBTU on Wednesday after trading as high as $3.03/MMBTU in early-morning electronic trading. Natural gas has been unable to find any sort of catalyst in the past week to stem the bloodshed as the near-term computer model outlook remains staunchly and relentlessly bearish. There has been no significant change in the near-term computer model outlook with both the ECMWF ENS and the GFS generally trending towards fewer gas-weighted degree days (GWDDs) over the next 14 days, as shown in the Figure to the right. The ECMWF, which most meteorologists regard as a superior model to the GFS, has been steadily converging towards the warmer GFS solution and, for a brief time yesterday was even forecasting fewer degree days than its American counterpart for the first time in several weeks. Not to be outdone, as the Figure shows, the GFS then trended even warmer over its last 3 runs to regain its bearish advantage. While both models still tease the potential return to colder temperatures late in their 14-day period, neither shows a convincing ridge of high pressure over Alaska or blocking Greenland high, which are both a favorable set-up for sustained arctic temperatures across the Lower 48. Click HEREfor more on the near-term degree day outlook on my Advanced Models Page.

Even with natural gas production trying to plateau and LNG exports rising past 5 BCF/day, it is the winter which means that the near-term temperature outlook remains the most important driver for natural gas prices. Without Mother Nature's cooperation, it is difficult, if not impossible, for natural gas to mount a sustained rally. This creates a particularly challenging investing environment at the present time. On the one hand, inventories remain at a robust storage deficit versus the 5-year average and the commodity is undervalued by 29% based on current inventory levels according to my Fair Price model. For these reasons, and the fact that we have seen the temperature forecast flip on a dime in the past, I would be very reluctant to get short natural gas under $3.00/MMBTU, even though prices could certainly move lower in the near term. This January Thaw is more than just a transient warm-up and is significantly cutting into the storage deficit. In fact, I expect that the year-over-year deficit will flip to a storage surplus by the end of January and that inventories will finish the heating season near 1515 BCF, a 155 BCF year-over-year surplus and a mere 115 BCF deficit versus the 5-year average. After entering December at the lowest level in 15 years with a year-over-year and 5-year average deficit of over -700 BCF, natural gas storage levels could come out of the withdrawal season at the third highest level in the last 5 years, as shown in the Figure to the right. Even if February turns out to be substantially--even historically--colder than January, making this outlook too bearish, it will be too little too late. There is no chance of any sort of storage crisis as some investors feared back in November and it would take an act of god for inventories to even fall under 1000 BCF. For this reason, the chances that natural gas prices top $4.00/MMBTU gain this winter are very small, and continuing to shrink with every day that passes. For this reason, my near-term price target has continued to be revised lower and now stands at $3.50/MMBTU, and this would require an exceptionally cold February, which does not look very likely at this time. Thus, with current sentiment extremely poor and maximum potential upside only around 15%-20%, this is not a high-probability set-up. I continue to feel that the best place to be is either minimally invested on the long side or on the sidelines waiting for a better entrypoint.

Of note, the EIA's weekly Natural Gas Storage Report for December 22-28 will be released on Friday at 10:30 AM EDT, delayed 1 day due to the New Year's Holiday.

Compared to natural gas, crude oil got off to a much stronger start to 2019. After trading under $45/barrel in AM electronic trading, WTI quickly broke higher at the open after a Bloomberg report revealed the Saudi exports dropped by 0.5 MMbbls/day in December, trading up more than 4% intra-session to over $47/barrel. Ultimately, WTI closed up $1.13 or 2.5% to $46.54/barrel while Brent settled up 2.1% to $54.91/barrel. It seems that, with 2019 now officially here, investors are more willing to buy into OPEC+'s efforts to rebalance global supply and demand. However, before WTI can make a move on $50/barrel, I feel that it will be necessary to see some evidence of this in the EIA's domestic inventory data (to be released 2 days late on Friday this week due to the New Years holiday). According to my Fair Price Model, the commodity is still undervalued by 22% versus a Fair Price of $60.20/barrel, which remains my long-term price target. At this time, I remain comfortable holding oil long even after Wednesday's bounce, but would refrain from adding to my position at prices over $45/barrel. Of note, after Apple reported a major earnings shortfall after Wednesday's close, US futures dropped precipitously and dragged oil down with it with the commodity trading down over 1.5% in Wednesday overnight trading to around $45.60/barrel.

After a lackluster end to 2018, my Oil & Natural Gas Portfolio got off to a strong start in 2019, rising as much as +1.8% intrasession on Wednesday before closing up +0.9%. The portfolio was led by my DWT short position and UWT long position which were up 5.5% and 5.4% on the session, respectively. My total long oil position, between long UWT and short DWT stands at 14.9% of my portfolio while my net long oil position stands at 8.2% with the remainder going towards offsetting a BNO short position worth 20% of my holdings as part of a Brent-WTI arbitrage trade. By buying and shorting roughly equal position sizes of UWT and DWT, respectively, I am negating leverage-induced losses while at the same time fixing my position size independent on movements in ETFs. This strategy is a sort of middle ground, missing out on profiting from leverage-induced decay if the entire position was short DWT while at the same time mitigating the risk of a purely short 3X ETF position. At this time, I am comfortable with my long oil position and plan to continue holding. Should WTI fall under $45/barrel, I will consider adding to the position via short DWT, though any increase would likely be small until I start to see US inventories decline. I am still looking to close my Brent-WTI spread trade out at a profit with a spread under $8/barrel (it was $8.37/barrel after yesterday's close). To do this, I would cover my BNO short position--currently up +30.9% from my basis--and my 6.8% UWT long position--currently up +7.1%--which almost perfectly offsets it. This would leave the portfolio short only DWT, currently valued at 7.8% of my portfolio. As I discussed earlier in this Commentary, I am not enthusiastic about the natural gas trade at this time and believe that the sidelines may be the best place to me. My current exposure stands at a modest 7.2% via short DGAZ, which, based on my analysis, may be too large of a position size. Despite the rapid decline and the fact that this position will likely continue to benefit from leverage-induced decay, I am strong consider reducing my position size to under 5% to await a better entry point, even at a substantial loss. My largest equity holding remains Cheniere Energy (LNG) at 10.4% of my holdings. The position was up 1.7% on Wednesday and is now nearly flat versus my basis. The LNG export company is benefiting from cheaper domestic natural gas prices, but is being held back by lower Asian prices and volatile US equities markets. At this time, I have no plans to add to the oversized position and am maintaining a $75/share price target on the company. Click HERE for more on my current oil and natural gas holdings.

Natural gas demand will turn lower today as unseasonably cold temperatures across the southern Plains are more than offset by building warmth across the northern Plains and Midwest. Winter Storm Warnings are up this morning for parts of Oklahoma and Texas including Oklahoma City and Wichita Falls where 2-6 inches of wet snow are possible on top of an overnight glaze of freezing rain. Highs in this area will only be in the 30s today while the major demand center of Dallas will struggle into the lower 40s, all 10F-15F colder than normal. However, this will be just about it for the below-average anomalies across the counrtry. Unseasonably mild readings will build into the northern Plains with Bismarck, ND reading the mid-40s and Omaha, NE near 50F, 15F-25F warmer-than-normal. It will also warm up across the Eastern Seaboard with the I-95 corridor from Washington, DC to New York City reaching the lower 50s and Boston the upper 40s, all 10F-15F warmer-than-normal. As a result, today's forecast mean population-weighted nationwide temperature will rise a substantial 3.1F from Wednesday to 44.5F, 5.5F warmer-than-normal. Total Degree Days will fall to 20.9 TDDs today, 5.6 TDDs fewer than normal and the 12th fewest for January 3 in the last 38 years since 1981. Click HERE for more on today's temperature and degree day data.

Based on this forecast and early-cycle pipeline data, I am projecting a -13 BCF/day daily natural gas storage withdrawal, 6 BCF smaller than Wednesday's draw and a massive 13 BCF bearish versus the 5-year average -26 BCF/day withdrawal. By late tonight, I project that Realtime natural gas inventories will be near 2607 BCF while the storage deficit versus the 5-year average will contract to -508 BCF, down 230 BCF from its November peak. The year-over-year deficit will continue its freefall, tumbling 39 BCF today to near -258 BCF by tonight, down nearly 70% from a peak of -712 BCF on December less than 3 weeks ago. Based on the near-term outlook, today's decline in natural gas demand will likely be only the first of 5 with daily draws to bottom out on January 7. Click HERE for more on today's projected daily storage withdrawal and Realtime natural gas inventories.