January 30, 2019

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Polar Vortex Edition: Record-Breaking Cold Arrives Driving Natural Gas Demand To A New 2019 High; EIA Forecast To Announce Modestly Bullish Crude Oil Inventory Build In Today's Status Report; Introducing A New Model To Calculate A Key Temperature-Independent Supply/Demand Balance Metric

6:00 AM EDT, Wednesday, January 30, 2019
Natural gas prices pulled out of their recent drive on Tuesday, recovering from early-session losses to finish the day in the black. After Monday's 8% sell-off, prices looked to continue where they left off yesterday, dropping another 2% out of the gates with the front-month prices falling under $2.85/MMBTU. However, the contract found its footing and began a modest rally after the early-February temperature forecast turned slightly cooler with prices eventually settling up 1.3% to $2.95/MMBTU. The February 2019 Front-Month Contract expired at the close of trading and will be replaced today by the March 2019 contract which closed Tuesday up 1% to $2.90/MMBTU after falling to $2.80/MMBTU early. While there were no major changes in the magnitude of the current arctic blast nor to the subsequent warm-up, the ECMWF and GFS did trend slightly colder with what looks to be the next arctic shot--around the February 8-10 timeframe--in what will remain a very progressive pattern. While, as discussed yesterday, the cold will have trouble expanding all the way to the Eastern Seaboard, the Great Plains and Midwest look to remain very cold, driving another storage withdrawal for February 9-15 that could approach -200 BCF. The Figure to the right plots projected daily natural gas storage withdrawals for the next 15 days showing the rapid decline in demand over the next 5-7 days followed by a nearly as rapid recovery late in the period as colder temperatures return. It is this new threat of cold that provided support to natural gas prices yesterday, plus the usual assortment of dip-buyers and profit-taking bears. My sentiment towards natural gas remains little changed from Monday. I feel that at current prices, the entirety of the upcoming warm-up is priced into the commodity while the threat of an extended cooldown during the second half of February has yet to be fully considered. Given how late in the withdrawal season we are, the threat of a serious price spike, like that seen in November, is extremely small and potential upside for the March contract is likely closer to $3.15/MMBTU to $3.20/MMBTU, at most. It is worth noting that with the recent sell-off, Futures prices for the next 8 months are nearly flat with minimal backwardation or contango, ranging from a low of $2.84/MMBTU for the April contract to $2.94/MMBTU for the October contract, as shown in the Figure to the right, a spread of only 10 cents. Barring a major move in either direction, this should minimize both rollover gains or losses for long and short ETF-holders. It also suggests that investors seem to be zeroing in on $2.90/MMBTU as a long-term Fair Price for the commodity, which I calculate as an undervaluation, near-term weather notwithstanding. At this time, I feel that natural gas prices under $2.90/MMBTU for the March 2019 contract represent a viable long entrypoint, both for a short-term swing trade on a bounce off the current sell-off and as a long-term hold. Since we are likely to see substantial chop as natural gas tries to establish a bottom and volatility as investors react and overreact to computer model runs, I again advise against buying 3x ETFs--UGAZ or DGAZ--for anything other than a daytrade or swing trade with a time horizon less than 10 days as these products will suffer from leverage-induced decay. Better options include buying or shorting 3x the volume of UNG or shorting the opposite 3x ETF (short UGAZ instead of buying DGAZ, short DGAZ instead of buying UGAZ) for the more risk-tolerant traders.

Meanwhile, crude oil prices reversed Monday's losses as investors cheered US treasury sanctions on Venezuela's state oil firm PdVSA. WTI prices rose $1.32 or 2.5% to $53.31/barrel while Brent rose a comparable $1.39 to $61.32/barrel. I am still skeptical that the situation in Venezuela will remain unresolved for long enough for sanctions to make a new dent in global oil supply/demand balance. I feel that this is a speculative rally setting up for a possible sell-off upon a near-term resolution. More important, in my mind, is today's EIA Petroleum Status Report covering January 19-25 which will provide further fundamental data and give insight on US supply/demand (im)balance. After Tuesday's close, the American Petroleum Institute (API) announced that it was forecasting a +2.1 MMbbl crude oil inventory build for the week. Now that we are in the oil build season, such a number would actually be quite bullish versus the 5-year average +7.4 MMbbl injection. Should it verify, inventories would climb to 447.1 MMbbls, the highest since November 23, but the storage surplus versus the 5-year average would drop to +31.8 MMbbls. Additionally, the EIA is reporting slightly bearish refined product builds with gasoline stocks expected to rise +2.2 MMbbls (5-year average: +0.9 MMbbls) and distillates to rise +0.2 MMbbls (5-year average: -1.9 MMbbls). Nonetheless, Total Petroleum Inventories (crude oil + gasoline + distillates) are forecast to rise just +4.5 MMbbls, still a modest 1.8 MMbbls bullish versus the 5-year average +6.3 MMbbls. Overall, I feel that should the EIA somehow report a crude oil inventory draw, prices would promptly rise north of $54/barrel (unless the Venezuelan crisis ends overnight) while even a small build at or smaller than the API's forecast could facilitate a second straight day of gains. I feel that a build over +5 MMbbls would favor a pullback with prices challenging Monday's close to the downside. My downside price target remains $50/barrel for WTI which I feel is achievable once the situation in Venezuela calms and if US supply/demand balance maintains the status quo. Longer term, I remain optimist on the sector an am targeting $60/barrel WTI and $70/barrel Brent in 2019. Check back on my Crude Oil Inventories Page HERE after 10:30 AM EDT for the official EIA storage numbers.

Natural gas demand will peak for the week--and likely the season--today as dangerous to record-setting arctic air dominates the Midwest extending into the Northeast. High temperatures will be exceptionally cold this morning, with Minneapolis falling to near -30F, Chicago to the low -20s, Indianapolis to -10F, and even Cincinnati, OH to near 0F, all 30F-40F colder-than-normal. Across Minnesota, Wisconsin, and northern Illinois and Iowa, these are some of the coldest temperatures since 1985, will decimate daily temperature records, and could even challenge all-time lows in some regions. Highs will not climb above zero in Chicago or Minneapolis today and will only reach the single digits from Columbus to Buffalo. However, the truly dangerous cold will be relatively concentrated to the Midwest and Great Lakes. Along the densely-populated I-95 corridor, highs will be in the mid-30s from Washington, DC all the way through Boston, generally only 5F-10F colder-than-normal. The Deep South will see similar anomalies with Dallas reaching the mid-50s, Jackson, MS near 50F, and Atlanta the upper 40s. However, you don't have to travel that far north to reach more substantial cold with Nashville, TN only seeing the mid-20s, more than 20F colder-than-normal. Despite the arctic air being relatively confined, its impact on US temperatures is still noteworthy. Today's forecast mean population-weighted nationwide temperature will fall 5.7F from Tuesday to just 29.5F, a brutal 10.3F colder-than-normal, a new 2019-low. Total Degree Days will rise to 35.3 TDDs, 9.6 TDDs greater than normal and the single most for January 30 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 -49 BCF/day daily natural gas storage withdrawal, 11 BCF larger than yesterday's draw and a massive 27 BCF bullish versus the 5-year average. By tonight, projected Realtime natural gas inventories will be near 2008 BCF and will quickly fall under 2000 BCF in the early morning hours on Thursday. The storage deficit will top -400 BCF again by early afternoon and will finish the day just under -410 BCF while the year-over-year will reach -120 BCF, up nearly 200 BCF in the past 10 days. Click HERE for more on today's projected daily storage withdrawal and Realtime natural gas inventories. Gas demand will inch only slightly lower with around a -47 BCF/day draw expected but the decline will then accelerate with demand expected to fall for 5-straight days with daily draws bottoming in the single digits by next Monday.

In other news, I am pleased to introduce a new model to calculate overall natural gas temperature-independent supply/demand balance. As all experienced natural gas traders know, variation in temperature is the great distractor in the natural gas sector. For example, the -20 BCF weekly storage withdrawal reported by the EIA over Christmas was exceptionally bearish, but occurred in the setting of unseasonably mild temperatures. Likewise, this week's expected withdrawal of -250 BCF is among the largest ever recorded, but also occurred when temperatures where historically cold. If it wasn't unseasonably mild over Christmas, would this draw still have been bearish? Would this week's draw still be bullish if temperatures were normal? Given enough time, these variations in temperature are likely to balance out with readings over a period of weeks to months coming out to near their long-term averages. Thus, in order to fully understand the long-term fundamentals of the natural gas market, it is necessary to isolate the temperature-independent supply/demand balance from all of the noise created by temperature swings. That is, if temperatures were at their long-term averages--which is a reasonable assumption when making long-term storage projections--will natural gas injections/withdrawals be greater than or less than their 5-year averages? This is easier said than done. I have created multiple models over the years to attempt to measure this statistic and all, in my opinion, have fallen short, perhaps until now. I have spent the past 1-2 months devising a new model and algorithm to determine temperature-independent supply/demand balance versus both the 5-year average and year-ago levels. This exact mechanics of the model are proprietary, but it uses the historical degree day and natural gas storage record to create an initial projection which is then fed into the a verification model that integrates EIA-reported supply/demand statistics. Based on this model, I calculate that the temperature-independent supply/demand imbalance versus the 5-year average stands at a rather modestly bearish -2.1 BCF/day versus the 5-year average, as shown in the Figure to the right.

During late last summer, when natural gas prices were trading under $2.80/MMBTU, nuclear outages were at a 1-year high, LNG feedgas demand was consistently hitting new records, Canadian imports were slumping, and before the latest slug of production came online, I estimate that supply/demand balance was briefly tight versus the 5-year average. This--along with some support from Mother Nature--allowed the storage deficit to defy expectations and remain above -500 BCF and set the stage for the November spike in prices. However, these demand-killing higher prices, combined with surging production, rebounding imports, and a rapid growth in production, resulted in the market dramatically loosening to a minimum of nearly -3 BCF/day by late December which likely contributed to that exceptionally weak -20 BCF weekly withdrawal. Since then, as production has plateaued and prices have fallen resulting in perhaps some fuel-switching, the market has tightened slightly to -2.1 BCF/day as of last week. Should prices remain under $3.00/MMBTU and LNG exports continue to grow as expected, it would be very possible for this imbalance to flip from loose to tight by this summer. Thus, a storage deficit versus the 5-year average of -400 BCF or more heading into the Spring is certainly no inconsequential and could set the stage for a comparable set-up as last Fall. The temperature-independent year-over-year imbalance, on the other hand, is considerably looser, at 4.4 BCF/day, driven largely by the 10 BCF/day growth in production over the past year, as shown in the Figure to the right. Similarly, however, should production growth slow and LNG exports rise, this imbalance, too, will rapidly contract. Temperature-independent supply/demand data is updated weekly on Thursday afternoon and can be found on my Supply/Demand Homepage HERE.