June 6, 2019

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Bearish Paradise: Oil Plunges Into Bear Market Territory After Disastrous EIA Status Report While Natural Gas Falls To 3-Year Low Amidst Cooler-Than-Normal Near-Term Temperature Outlook; EIA Projected To Announce 11th Straight Bearish Storage Injection Today

6:00 AM EDT, Thursday, June 6, 2019
In its weekly Petroleum Status Report, the EIA announced Wednesday morning that crude oil inventories rose by +6.8 MMbbls during the week of May 25-31. This was a massive 7.1 MMbbls bearish versus the 5-year average -0.3 MMbbl draw and was nearly double the American Petroleum Institute's already-bearish +3.6 MMbbl forecast. With the build, inventories rose to 483.3 MMbbls, a more than 2-year high. Storage is up 46.7 MMbbls from a year ago and a storage deficit versus the 5-year average as recently as mid-March has ballooned into a +32.0 MMbbl surplus. There were multiple bearish drivers that led to this unexpectedly large build. First, crude oil imports surged by 1.1 MMbbls/day from the week prior to 7.93 MMbbls/day, the highest since the second week of January. This was due largely to imports from Canada jumping 0.7 MMbbls/day week-over-week to 3.87 MMbbls/day, the second highest level on record. If there is a silver lining to this rise, there is nothing to suggest a sustained increase in Canadian imports is imminent and it is likely that this is nothing more than a short-term fluctuation. Additionally, domestic production rose by 0.1 MMbbls/day for a third straight week to 12.4 MMbbls/day, a new record high and 1.6 MMbbls/day higher year-over-year. Finally, refinery input demand is still struggling to break out of its slump. Inputs averaged just 16.94 MMbbls/day, up a sluggish 0.2 MMbbls/day from the previous week and down a disappointing 0.4 MMbbls/day from 2018. As the Figure to the right shows, refinery demand hasn't topped 17 MMbbls/day since the first three weeks of 2019. It would be one thing if weak refinery demand meant that gasoline and distillate inventories have been tight but, sadly for the bulls, that has not been the case. Gasoline stocks rose +3.2 MMbbls--bearish versus the 5-year average +1.8 MMbbls--while distillates +4.6 MMbbls, the largest gain this year and also above its +2.8 MMbbl 5-year average. Inventories for both are within 5 MMbbls of their respective 5-year averages with gasoline at a small surplus and distillates at a small deficit.

Even with these bearish numbers, such a supply/demand balance would still only equate to a +1.2 MMbbl build. And thus, unsurprisingly, the EIA reported another large correction factor of 0.8 MMbbls/day--or 5.6 MMbbls/week--which it uses to square the reported inventory build and the much tighter supply/demand balance. Either imports are being underestimated (which seems unlikely given they were near yearly highs), exports are overestimated (possible), or production is really north of 13 MMbbls/day. This seems unlikely as well given natural gas and oil production have moved in tandem for the past 5+ years. Gas production has been flat for over essentially the entirety of 2019 and it would be odd for oil production to suddenly diverge and rise over 1 MMbbl/day. Regardless, something very odd is going on with these weekly numbers, which is likely only increasing investor anxiety and boosting volatility in the sector.

And boosted volatility has been. Honestly, there was very little to like about this report if you are an oil bull and Wednesday's trading session reflected this sentiment. WTI plunged $1.80 or 3.4% to $51.68/barrel, after trading briefly under $51/barrel. It was the lowest close since January 11. Losses from recent highs near $66/barrel have now topped 20%, officially pushing the sector into bear market territory. Brent traded down a somewhat softer $1.34/barrel to $60.63. So is the sell-off warranted? Oil inventories are now at their highest since July 21, 2017. At that time, WTI was trading at $45.77/barrel, a more than 10% discount to current prices, and evidence that the pullback may not that farfetched. However, looking at a longer term picture of the storage-price relationship over the past 3 years rather than just a single datapoint, WTI's Fair Price is actually closer to $59.80/barrel, a 13.4% undervaluation. In the end, however, whether oil is under- or over-valued will depend on whether the market tightens up, as many traders have been expecting for over a month now. If the status-quo is maintained, this Fair Price will plunge under $45/barrel before the end of 2019, as shown in the Figure to the right. If however, we finally start to see withdrawals, I expect the commodity to rapidly trace back towards its Fair Price. Despite the recent steep losses, I am remaining cautiously bullish on the sector, fully expecting imports to fall, refinery output to rise, and the correction factor to collapse. However, based on this Fair Price data, I am revising my price target from $65/barrel down to $60/barrel.

Meanwhile, natural gas continues to struggle as well, though not to the same extent as oil. The July 2019 front-month contract slid another 1.6% on Wednesday to $2.38/MMBTU. Despite inventories that are still at a storage deficit versus the 5-year average, this is a new 3-year low. Prices were last under $2.40/MMBTU on June 1, 2016, when inventories were 1000 BCF higher than today. The ongoing sell-off and steep discount versus the historical storage-price relationship can be attributed to an underlying loose temperature-independent supply/demand imbalance driven by strong year-over-year production gains and the forecast for consistently below-average June temperatures across the Central US. As the Figure to the right shows, both the GFS ENS and ECMWF ENS models are both forecast at-or-below average gas-weighted degree days (GWDDs) over the next 14 days. This will likely drive triple digit weekly builds at least through the week ending June 14. Nonetheless, cheap prices will begin to fuel at least some tightening of the supply/demand balance due to stronger demand, but any sustainable rally will ultimately depend on Mother Nature cooperating with warmer temperatures during the second half of the month. My upside price target remains $2.60/MMBTU, though I wouldn't be surprised to see more near-term weakness, perhaps even as low as $2.25/MMBTU due to the sheer momentum of the selling as well as the admittedly bearish forecast.

With the steep sell-offs in natural gas and especially oil, it was another rough day for my Oil & Natural Gas Portfolio on Wednesday. The fund slid -2.1%, reducing 2019 year-to-date gains to +8.5%, or +19.5% annualized. I made no trades on Wednesday and remain in a holding pattern, maintaining my oil and natural gas long positions. Click HERE for more on my current holdings.

The EIA will release its weekly Natural Gas Storage Report for May 25-31 this morning at 10:30 AM EDT. I am projecting a +109 BCF storage injection, 7 BCF bearish versus the 5-year average. It will be the fourth straight triple digit injection and the twelfth straight bearish injection. As the Figure to the right shows, it would be the third largest injection, behind a +117 BCF build in 2017 and +126 BCF in 2015. Overall, temperatures were neutral for the week--slightly above average--with the bearishness of the build driven by the loose underlying supply/demand imbalance. Should a +109 BCF injection verify, natural gas inventories would rise to 1976 BCF while the storage deficit versus the 5-year average would contract to -250 BCF and the year-over-year surplus would rise to +172 BCF. Click HERE for more on this projected storage injection.

With natural gas investors fixated on the bearish June forecast and likely swept up in the pessimism surrounding fellow commodity crude oil, it is unlikely that a smaller-than-expected build will mark a bottom in the sector and start a sustainable rally. On the other hand, a bearish miss would only reinforce the current sentiment. Personally, I disagree with this expected course. The most important thing going forwards will be the temperature-independent supply/demand balance and if today's data shows any tightening of that balance, it will suggest that lower prices are finally having an impact and could result in smaller builds later this summer once temperatures warm back up. As it stands, though, I feel that it would take a reported injection of under +102 BCF to be consider unequivocally bullish and supportive of a rebound in prices back above $2.40/MMBTU. On the other hand, I feel that it would take an injection of only +112 BCF or higher to be considered another bearish disappointment that could drive prices towards $2.30/MMBTU near-term. A reported injection between +102 BCF and +112 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.