October 4, 2018

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Natural Gas Soars For Third Straight Day As Large-Scale Revaluation Underway; Crude Oil Continues Its Rally In Confounding Fashion After EIA Reports Largest Storage Injection Of The Year; EIA Projected To Announce Slightly Bearish +90 BCF Storage Build In Today's Report

6:00 AM EDT, Thursday, October 4, 2018
Natural gas surged to a third straight day of gains on Wednesday as a large-scale and long overdue re-valuation of the commodity continues. The front-month November 2018 contract finished up 6 cents or 2.3% to settle at $3.23/MMBTU, the highest settlement since January 29. The peak January 2019 contract closed at $3.37/MMBTU, within 10% of last year's highs, itself a nearly 4-year high. After lagging year-ago prices for nearly the entire summer, the commodity is now up 10.8% year-over-year. The center of the natural gas investor's universe has abruptly become inventories that are at multi-year lows and seem unlikely to top 3300 BCF before the end of the storage injection season, more than 500 BCF below the 5-year average and a 5-year low by over 300 BCF. For much of the summer, investors were fixated on the otherworldly growth in production, now up over 10 BCF/day year-over-year, keeping a lid on prices. But with inventories now the focus, natural gas prices have understandably surged to just below my near-term price target of $3.25/MMBTU. Based on my Fair Price Model comparing current inventories and natural gas prices to historical levels, the commodity remains undervalued, with a Fair Price over $4.00/MMBTU. However, record production cannot be ignored and with computer models still hinting at a warmer-than-average temperatures in early November, I still feel that the storage injection season will be prolonged. With increased price volatility comes an increase in sentiment volatility. At some point, natural gas bears will re-enter the picture and prices will likely pull back sharply. As painful as it is right now and even as the path of least resistance remains higher, natural gas prices above $3.25/MMBTU will be a good entrypoint for a short trade with further additions should prices continue to rally.

In its weekly Petroleum Status Report, the EIA seemingly stunned investors with a massive +8.0 MMbbl crude oil inventory build for the week of September 22-28. The build was very bearish versus the 5-year average -0.2 MMbbl draw and was the largest injection of 2018, as shown in the Figure to the right. It was also the largest injection for September 22-28 period in the last 5 years, easily topping 2013's +5.5 MMbbl build. The build was driven by a 917,000 barrel/day decline in exports to just 1.7 MMbbls/day despite the Brent-WTI spread holding near $9/barrel and a 163,000 barrel/day increase in imports. If there is a silver lining, it is that refinery demand rose 8,000 barrels/day week-over-week and production held steady. It is also possible that this was just an off-week for timing of exports and outflows will rebound sharply in the next 1-2 weeks. Nonetheless, with the build, crude oil inventories rose back above 400 MMbbls for the first time in 4 weeks to 404.0 MMbbls while the storage deficit versus the 5-year average contracted back right to the 5-year average. The year-over-year deficit plunged by 14 MMbbls to -61 MMbbls. Silver linings notwithdstanding, this was a bearish report in every sense of the term and, with oil up nearly 10% in the past 2 weeks, the stage seemed set for a serious pullback.

Except the exact opposite happened.

After a transient dip in the minutes following the report, WTI quickly rallied and rose by $1.18 or 1.6% to $76.41/barrel while Brent oil rose an even steeper $1.49 to $86.29/barrel. It is still unclear what drove the rally. It is hard to say that it was a sigh-of-relief rally because the injection, while bearish, wasn't as large as was feared. It was. Most likely, investors are treating this week as a one-off event with expectations for a return to storage draws in the weeks to come and instead focused on geopolitics and the impending Iranian sanctions to drive prices higher. However, oil is running out of catalysts to prop up Brent at nearly $90/barrel in this environment. Oil is one bearish story away from pulling back sharply. WTI oil is now approaching my $77/barrel price target while Brent is well in excess of its target. At this juncture, given Thursday's report, I see near-term downside risk outweighing upside potential. My 2018 price target for Brent is $80/barrel while WTI should settle around $75/barrel.

My Oil & Natural Gas Portfolio fell for a second straight day, weighed down by an increasingly cumbersome natural gas short position. The Portfolio fell -0.5% on Wednesday, but finished well off the lows of the day. With the rally in natural gas, my short position has become quite large, standing at 11.4% of my holdings. A 20.8% short UGAZ is partially offset by a 9.4% DGAZ position. I had mentioned my plan in Wednesday's commentary to add to my short position should natural gas top $3.20/MMBTU, but I decided against this based on the sheer momentum of the current rally. I will again consider this trade should the commodity top $3.30/MMBTU. Otherwise, I am content to let the position ride and for leverage-induced decay to eventually wear the 3X ETFs down. My maximum target position size for this trade is net short 15% of my portfolio should I decide to add to the position. Following the somewhat confounding spike in WTI following the EIA's reported +8.0 MMbbl inventory build, I took profits on a portion of my net long WTI trade. I covered a 3% stake in DWT for a profit of +37%, reducing long exposure to under 2%. The remainder of my short DWT position goes towards offsetting a 20.8% short position in BNO, the 1x Brent ETF as part of Brent-WTI arbitrage trade that will be profitable when the spread between these two price points contracts. Should the Brent-WTI spread top $10/barrel, I will likely add to this position further. Click HERE for more on my current oil and natural gas portfolio.

The EIA will release its weekly Natural Gas Storage Report for the week of September 22-28 that ended last Friday this morning at 10:30 AM EDT. I am projecting a +90 BCF storage injection, 6 BCF bearish versus the 5-year average and a huge 45 BCF larger than last year's injection. As the Figure to the right shows, a +90 BCF storage injection, despite being slightly bearish, would actually be the third smallest in the last 5-years behind only the much smaller +71 BCF and +44 BCF injections from 2017 and 2014. In contrast, 2014 saw a +110 BCF injection, which is the type of build that many were thinking that we would be seeing this time of year with production as high as it is. The large weekly increase in the natural gas storage injection was driven by much cooler temperatures across the eastern half of the nation, with the mean population-weighted nationwide temperature averaging 70.4F, down 5F week-over-week. This suppressed powerburn demand which average just over 30 BCF/day on the week. Additionally, the Cove Point LNG export plant remained out of commission for scheduled maintenance for the entire week, cutting 0.7 BCF/day of feedgas demand to the plant. While nuclear reactor outages remained at 5-year highs throughout the week, even this wasn't able to compensate for the loss of cooling demand. Should a +90 BCF injection verify, natural gas inventories would rise to 2858 BCF while the storage deficit versus the 5-year average would contract only slightly to -615 BCF. The year-over-year deficit would fall more steeply to -644 BCF. Click HERE for more on this week's storage injection.

Given the rally in natural gas and the fact that today's report looks to be at least slightly bearish, there will be considerable pressure for the EIA-reported injection to come in below analyst expectations. I feel that it would take a +85 BCF or smaller injection to be considered unequivocally bullish and sufficient to drive prices towards $3.30/MMBTU. On the other hand, a reported build of over +95 BCF would be considered unequivocally bearish and would fuel a near-term pullback to perhaps $3.15/MMBTU while a surprise triple digit injection could at least temporarily put a halt to the rally and favor an even sharper pullback. A reported injection between +85 BCF and +95 BCF would be neutral versus expectations with prices equally likely to rally or pullback.

Check back at 10:30 AM EDT for the official EIA storage withdrawal on my Current Natural Gas Inventories Page HERE. Also, I now have weekly natural gas supply and demand statistics on my Natural Gas Supply & Demand Page HERE that should be updated between 3 pm and 4 pm EDT.

Natural gas demand will rise slightly today as unseasonably warm temperatures continue to dominate the eastern seaboard even as a Canadian airmass infiltrates the Plains. Highs along the I-95 corridor will reach the mid-80s as far north as New York City today while isolated areas in the Carolinas could top 90F, 15F-20F warmer than average. This will keep the air conditioners running to pump up powerburn. On the other hand, some areas of the Great Plains will cool upwards of 35F day-over-day with St Louis, Omaha, and Des Moines all only reaching the upper 50s today after topping out near 90F on Wednesday. This will wipe out powerburn demand and wont be sufficient to drive heating demand. Further north, across Minnesota and the Dakotas, lows will drop into the upper 20s and lower 30s this morning which should be sufficient to prompt at least modest heating demand. Overall, the forecast mean population-weighted nationwide temperature today will drop by 2.9F from Wednesday to 70.6F, still a massive 6.3F warmer-than-normal. Total Degree Days will hold nearly steady at 10.0 TDDs, 2.9 TDDs greater than normal and the 7th most for October 4 in the last 38 years since 1981. Based on this forecast and early-cycle pipeline data, I a projecting another +13 BCF/day daily natural gas storage injection, around 0.3 BCF smaller than Wednesday's build and just below the 5-year average. Click HERE for more on today's projected storage injection and Realtime inventories. Gas demand will continue to rise on Friday as heat builds back into Texas, the nation's biggest natural gas-consuming state, driving a slightly bullish +11 BCF/day inventory build. Overall, for the full week of September 29-October 5, I am projecting a neutral injection, similar to last week, of right around +89 BCF. I will have more on this week's projected injection tomorrow, but for now, see my Weekly Storage Page HERE.