November 5, 2018

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Natural Gas Poised To Open Higher At Today's Open As Computer Models Trend Consistently Colder Over The Weekend--But Are The Gains Sustainable? Gas Demand To Fall Today In Third-To-Last Daily Injection Of The Season As East Warms; Nuclear Reactor Outages Peak Driving Natural Gas Substitution Demand Lower

6:00 AM EDT, Monday, November 5, 2018
Natural gas prices staged a sharp reversal on Friday, rallying from a nearly 2% early-session deficit to close up 5 cents or 1.5% at $3.28/MMBTU. The rally was driven by a dramatic cooling trend in afternoon computer model runs for the 2nd-3rd weeks of November as a deep trough now looks to sink all the way to the Gulf of Mexico, allowing arctic air to blood south. In fact, given the considerably more bullish picture, I was surprised that natural gas did not rally more. Regardless, the commodity finished the week up a modest 1.8% and prices are up 3.4% year-over-year. However, that year-over-year margin is poised to grow considerably as prices spiked at the onset of electronic trading on Sunday evening, trading up a massive 7% to over $3.50/MMBTU. While prices pulled back somewhat by the early-morning hours , the December 2018 front-month contract was still up nearly 5% at the time of this writing. The reason for the pre-market rally is, of course, the fact that both the GFS and ECMWF computer models have remained relatively consistent in their forecast of unseasonably cold temperatures across almost all areas east of the Rockies beginning this Wednesday behind a potent storm system that will quickly flip daily storage injections to withdrawals. With several reinforcing shots expected over the next 10+ days, the storage deficit versus the 5-year average could make a run for -650 BCF and a new 4-year high. Does this justify prices over $3.50/MMBTU? I am skeptical. At this time, the long-range computer models continue to call for a return to above-average temperatures during the second half of the month, although these models have been unreliable of late. Nonetheless, with record production, falling nuclear reactor outages, and an impending rebound in Canadian imports, I expect investors will be quick to sell if and when computer models flip back to a milder solution. For this reason, I am maintaining a $3.50/MMBTU price target on natural gas and would strongly recommend taking profits near this benchmark.

Crude oil, meanwhile, continued its disheartening slide on Friday, with WTI falling another 55 cents or 0.9% to settle at $63.14/barrel and Brent falling just 6 cents to $72.83/barrel. It was the lowest close for WTI since early April. The commodity lost 6.6% on the week, its fourth straight week of declines. Investors are ignoring pending sanctions on Iran and are more focused on higher-than-expected US production and strong gains in Saudi and Russian production that are expected to mitigate Iranian losses. While I believe that oil was likely overpriced when WTI topped $75/barrel, I do feel that the sell-off has overextended to the downside. My near-term price target for WTI is $70/barrel.

Fueled by losses in the oil sector, my Oil & Natural Gas Portfolio slid again on Friday, falling 0.5% to bring weekly losses to -1.2%. Year-to-date gains have been reduced to +14.9%, or +17.6% annualized. The portfolio is down over 6% since last reaching new 52-week highs in mid-September, the largest pullback in over a year. What's frustrating is that the majority of my positions have been working with my oil net long trade paying dividends on a cold start to the heating season and GLNG and LNG both in the black. However, my net long oil trade has been punished early and often. Despite timing the top of the rally and taking profits on half of my net long position, the remaining portion of my short DWT trade has seen +30% profits reduced to a -18.1% loss as of Friday. As I had become overexposed in an underperforming, 3x leveraged short position, I made the difficult decision on Friday to mitigate risk and reduce my net long position by over half, reducing net long exposure to 7% of my portfolio. The remainder of my 14.7% short DWT position is offset by a short BNO position as part of a Brent-WTI arbitrage trade, as discussed previously. At this time, I plan to continue holding these positions as they are, but should net long exposure top 10% of my holdings, I will reduce risk again and cover to knock exposure back to 7.5%. Regarding natural gas, should the commodity open at $3.45/MMBTU or higher this morning, I will likely take profits and even consider flipping to a small net short position as I believe that the commodity will struggle to hold this threshold when the outlook trends warmer in the setting of rising production. My upside price target remains $3.50/MMBTU and I have no plans to revise it higher at this time. Any net short position would not exceed 5% of my portfolio and my downside target would be $3.20/MMBTU. Click HERE for more on my current oil and natural gas holdings.

Natural gas demand will likely weaken further on Tuesday as the East trends even milder with a double digit daily storage injection possible. At the same time, however, a potent arctic airmass will make its way into Montana and the Dakotas by Tuesday evening. Over the next 3 days, this trough will dig southward, driving unseasonably chilly temperatures all the way to the Gulf Coast by Friday. The Figure to the right shows the dramatic change in the temperature pattern. As a result, I am expecting a -3 BCF/day daily storage withdrawal on Friday, a full 13 BCF swing from Tuesday's bearish build. Nonetheless, thanks to early-week oversized injections, this end-of-the-week surge in demand will come too little too-late and I am currently projecting a +32 BCF inventory build for the first full storage week of November, 14 BCF bearish versus the 5-year average and a large 47 BCF bearish versus a year ago. Inventories will rise to 3240 BCF--although will likely peak just under 3245 BCF intra-week--while the storage deficit versus the 5-year average will contract to -608 BCF. Click HERE for more on the near-term temperature outlook.

While the arctic surge will be too late this week to drive a bullish withdrawal, the early-season chill will likely peak next week resulting in the first storage withdrawal of the season. After the initial arctic invasion, the models suggest a quick-hitting series of reinforcing shots of Canadian air through November 15. As a result, for the following week of November 10-16, I am projecting a very preliminary -70 BCF withdrawal, a huge 45 BCF bullish versus the 5-year average, enough to the drive the storage deficit to a new 4-year high of over -650 BCF. However, as the Figure to the right shows, after daily storage withdrawals peak at around -13 BCF/day on November 13, demand could quickly weaken with the GFS and longer-term EPS models both showing a more bearish pattern setting up. By November 16 and 17, daily withdrawals could fall below the 5-year average and even potentially flip back to daily injections. It is for this reason that, as discussed in the introduction to this commentary, that I am skeptical if a rally above $3.50/MMBTU is sustainable and I would use such an opportunity to take profits on long positions. Click HERE for more on near-term natural gas storage projections.

In other news, nuclear reactor outages, which soared to 5-year highs over the past two months, likely peaked for the season last week. After reaching 550 GWh, outages fell the last four straight days to wrap up the week, settling Friday at 453 GWh, or 19% of US capacity. Nonetheless, outages are still a robust 48 GWh or 12% above the 5-year average and 101 GWh or 28% higher than last year. As a result of the decline in outages, natural gas substitution demand fell back under 4 BCF/day to 3.78 BCF/day as of Friday. Substitution demand is still 0.5 BCF/day above the 5-year average and 0.9 BCF/day higher than last year. Over the past 60 days since the maintenance season began, strong substitution demand on its own has directly contributed a 35 BCF contraction in the storage deficit versus the 5-year average. With a slew of reactors expected to come back online this week, I expect nuclear outages to continue to decline and expect substitution demand to be a decreasing determinant of natural gas supply/demand balance. Click HERE for more on nuclear reactor outages, updated each morning.