September 5, 2018

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Natural Gas Slumps 3% To Start Shortened Week On Record Production & Tropical Storm Gordon; Gordon Disrupts Flows To Sabine Pass LNG Export Plant; Mid-September Outlook Trends Hotter, But Downside Risk Remains; Oil & Natural Gas Portfolio Approaches New Highs

6:00 AM EDT, Wednesday, September 5, 2018
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Natural gas tumbled to start the holiday-shortened week, falling 9 cents or 3.2% to $2.82/MMBTU, the lowest closing price since August 2. The commodity is now down 5.5% year-over-year.

With Tuesday's losses, only the January 2019 contract remains above $3.00/MMBTU for the next 12 months and the May 2019 contract is now in the $2.50s/MMBTU. The pullback came in the wake of the EIA reporting new all-time production highs last Thursday, amplified as the September 6-10 outlook trended colder and Tropical Storm Gordon spun up as a bearish influence on Gulf Coast powerburn. Even as the mid-September forecast did trend hotter across the Heartland, potentially driving yet another surge of late-Summer heating demand by around September 12, it is becoming increasingly apparent that Mother Nature is unable to keep pace with the building supply/demand imbalance, which I calculated last week at a massive -5.0 BCF/day. While inventories will undoubtedly enter the heating season at a large deficit--currently projected to be at least -250 BCF--a potentially warmer-than-average winter with this imbalance could result in a storage surplus as early as February or March 2019. Even the expected surge in LNG export capacity in early 2019 may not be enough to rebalance the market should production continue to grow at its current rate. For this reason, I am maintaining a $2.75/MMBTU near-term price target on natural gas, a level which I feel is needed to increase fuel-switching and perhaps slow the momentum of production growth.

Crude oil jumped over 2% to an intraday high of $71.40/barrel early Tuesday morning, but was unable to hold its gains and finished the session up a mere 7 cents or 0.1%. The afternoon fade was likely driven by expectations that Tropical Storm Gordon was unlikely to significantly disrupt oil production--17% of which is in the Gulf of Mexico with expected shut-ins at only 9.2% of this mark--and by fears of rising OPEC oil production. The commodity had found support recently thanks to falling Iranian output ahead of sanctions, an increase in violence in Libya, and by larger-than-expected US inventory drawdowns. This week's Petroleum Status Report detailing inventory changes and supply/demand data for August 25-31 will be delayed one day until Thursday this week due to the Labor Day Holiday. Pending assessment of this data, I am cautiously maintaining a $75/barrel near-term price target on WTI crude oil.

My Oil & Natural Gas Portfolio rose +0.4% on Tuesday to push 2018 gains to-date to +18.6% through the first 170 trading days of 2018, or +27.5% annualized. The Portfolio is back to within 0.5% of all-time highs. Gains on Tuesday were driven by my net natural gas short position thanks to a more than 10% decline in UGAZ, partially offset by a 10% rally in DGAZ. After the pullback, my net long position is contracted down to 4.3% of my holdings thanks to the movements of these ETFs. As discussed above, my price target is $2.75/MMBTU and I have not intention of taking any profits ahead of this mark. Should natural gas reach $2.75/MMBTU, I will likely flip directly to a net long position by covering a portion of my UGAZ short and transferring these funds to a DGAZ short. Should natural gas rally from here, I will look to add further to my UGAZ short should the commodity top $2.90/MMTBU on anticipation of a hotter mid-September. I embrace an increase in large intraday moves as seen yesterday as these increase the rate of leverage-induced decay, which is the whole point of maintaining partially offsetting UGAZ/DGAZ positions. While WTI oil finished with a small gain, DWT actually rose 2.6% on Tuesday, meaning that my short position, providing long exposure, was down 2.6% on the day. The position is still up +20% from my basis, however. At this time, I plan to continue holding this position with a $75/barrel price target. One oil sector trade that I am considering is the re-initiation of a Brent-WTI arbitrage trade, something that I found success with earlier in the summer. After rising to over $11/barrel early this summer and then collapsing to just over $3/barrel in late July, the Brent-WTI spread has ballooned back up to $8.30/barrel with Tuesday's Brent close of $78.17/barrel, nearly 3x the 4-year average of $2.50-$3.00/barrel since Obama approved US exports. I feel that that as this spread increases, there will come pressure for either gains in WTI to outpace Brent gains or Brent losses to outpace WTI losses, narrowing this spread down. The execution of this trade involves shorting (more) DWT to gain WTI long exposure while selling short equal exposure in the Brent ETF BNO (3x the net value of the DWT short as this is a 1x ETF to DWT's 3x ETF). This trade will be profitable should the Brent-WTI spread contract. With a 55% cash position, I am willing to allocate 25% of my holdings to the trade, which would be approximately a 6% DWT short and an 18% BNO short. Ideally, I would initiate this trade should the Brent-WTI spread top $9/barrel with a target spread of $5/barrel. Click HERE for more on my current investment holdings.

Natural gas demand will fall today as a weakening Tropical Storm Gordon brings heavy rain and cool conditions across the South and a Fall-like storm system across the Plains drags down cool, Canadian air. Nonetheless, it will remain hot yet again across the Northeast with highs in the low-90s in Washington, DC and Philadelphia and upper 80s from New York City to Boston, each 10F-15F above-average. Even inland temperatures will remain hot with Pittsburgh and Detroit both approaching 90F, 10F above-average. However, after making landfall Tuesday evening at near hurricane strength, Tropical Storm Gordon will spin down across Mississippi and Louisiana, but will bring temperatures only in the upper 70s and lower 80s from Jackson and Hattiesburg in Mississippi to southeastern Arkansas, up to 10F below-average. Powerburn loss due strictly to power outages looks to be rather limited with less than 75,000 outages as of early this morning. However, it is worth noting that based on early-cycle pipeline data, LNG feedgas demand to Sabine Pass will drop to 1.7 BCF/day today, the lowest since August 7, driving total LNG demand to 2.41 BCF/day today. While Tropical Storm Gordon is making landfall 350 miles east of the facility, the facility may be restricting inflows either due to precautionary measures or because the storm is disrupting tanker traffic in the Gulf. At this time, I am projecting weekly LNG feedgas demand at 19.2 BCF, down 2.1 BCF from last week and the lowest of the summer. Click HERE for more on LNG exports.

However, the cooldown will not last as mentioned at the beginning of this Commentary, as the mid-term 10-14 day temperature outlook has trended hotter over the past 3 days. As the NWS 8-14 day temperature outlook in the Figure to the right shows, much above-average temperatures are expected across the Central Plains and Northeast. In fact, some of the computer models are projecting some of the hottest temperatures of the summer for the Plains with highs well into the 80s and even 90s. Despite the forecast large anomalies, the deeper that the calendar moves into the Shoulder Season, the less significant that such anomalies become and the more impactful record production becomes. Thus, should natural gas rally on expectations for a hot mid-September, I will view such a move as another shorting opportunity and will plan to take full advantage. Click HERE for more on the extended temperature outlook.