February 8, 2019

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Natural Gas Priced For Imperfection As Prices Fall To A 2-Year Low After EIA Storage Miss & Warming Long-Term Models; Key Temperature-Adjusted Supply/Demand Imbalance Metric Loosens As LNG Exports Fall; Gas Demand To Soar Today With The First Bullish Daily Withdrawal In Over A Week Likely As Arctic Air Floods South

6:00 AM EDT, Friday, February 8, 2019
Natural Gas Priced For Imperfection As Prices Fall To A 2-Year Low After EIA Storage Miss & Warming Long-Term Models; Key Temperature-Adjusted Supply/Demand Imbalance Metric Loosens As LNG Exports Fall; Gas Demand To Soar Today With The First Bullish Daily Withdrawal In Over A Week Likely As Arctic Air Floods South In its weekly Natural Gas Storage Report for February 26-January 1, the EIA announced Thursday morning that natural gas inventories fell by -237 BCF. While this was 122 BCF bullish versus the 5-year average, it was smaller than almost all analyst guidance, including 9 BCF smaller than my projected -246 BCF draw. It was the second straight disappointing weekly EIA-reported draw, following last week's -173 BCF decline. With the withdrawal, natural gas inventories fell to 1960 BCF, while the storage deficit versus the 5-year average jumped to -415 BCF and the year-over-year deficit rose to -135 BCF. The bullishness of the draw was driven by the South Central region's -79 BCF withdrawal (5-year average: -38 BCF) and the Midwest's -59 BCF draw (5-year average: -51 BCF). The core of the polar vortex that drove demand to record levels last week was focused across the Heartland, including the Midwest in the North and the South Central in the south. The East was spared the brunt of the chill and reported a relatively disappointing -59 BCF withdrawal, just 14 BCF bullish versus its 5-year average, while the Pacific and Mountain regions were missed entirely by the arctic air and reported draws on either side of their respective 5-year averages. Inventories in all 5 regions remain at sizable deficits versus their respective 5-year averages, led by the South Central's -166 BCF deficit, while all 5 have also flipped back to year-over-year deficits led by the Pacific region and it's -41 BCF deficit. Click HERE for more on the latest EIA-reported natural gas inventories.

After releasing its storage data in the morning, the EIA followed up with its natural gas supply and demand data in the afternoon. It should be noted that this data covered the period of January 31-February 6, which differs from the period for weekly storage data, which was February 26-January 1. On the supply side, the EIA reported that domestic production remained flat, falling 0.2 BCF/day week over week to 87.4 BCF/day. Natural gas production reached 87.9 BCF/day on October 31, 2018 and over the past 3+ has largely been flat. This may be attributable to both short-term freeze offs as well as the Enbridge pipeline explosion in Ohio on January 31, both of which will be time-limited events. Regardless, after production surged from 80 BCF/day to 88 BCF/day in just 4 months from July to November, growth has clearly slowed. Nonetheless, production remains up 8.5 BCF/day year-over-year, although these year-over-year gains have slowly begun to decline. Also on the supply side, the EIA reported that Canadian imports plunged by 1.3 BCF/day last week to just 4.7 BCF/day, down 1 BCF/day year-over-year. These losses are likely short-term related to arctic temperatures and will recover in the weeks to come. The bullish decline in Canadian imports was countered on the demand side by another steep drop in LNG exports, which slumped 1.2 BCF/day week-over-week to just 2.8 BCF/day, due largely to losses at the Sabine Pass plant in Louisiana. Exports are barely more than half their current capacity of over 5 BCF/day and are down year-over-year (by -0.6 BCF/day) for the first time in over a year. Thanks to slumping LNG exports and the smaller-than-expected EIA-reported storage withdrawal, I calculate that temperature-adjusted supply/demand imbalance loosened last week by 0.6 BCF/day to 1.7 BCF/day loose versus the 5-year average. This means that, for any given temperature, the expected storage withdrawal would be 1.7 BCF smaller than expected based on the 5-year average. It is important to normalize for temperature when assessing the supply/demand imbalance as short term cooling or warming periods will dramatically alter this imbalance and mask the underlying strength or weakness in the market. The temperature-adjusted supply/demand imbalance is a useful tool for predicting the future fundamentals of the sector heading into the Shoulder Season this spring. As the Figure to the right shows, the supply/demand imbalance peaked at nearly 3 BCF/day loose versus the 5-year average back in late November and early December when natural gas prices were trading north of $4.50/MMBTU. Since then, as production has plateaued and much cheaper prices have made the fuel more competitive, the market tightened considerably, at least until this week. It remains to be seen whether the loosening seen this week is temporary, as a result of weak LNG exports or some other time-limited factor, or is part of a developing trend. Stay tuned as this will have significant impacts heading into the end of the heating season. Click HERE for more on the latest EIA-reported supply and demand data.

Natural gas continued its free-fall on Thursday, slumping 11 cents or 4.2% to settle at $2.55/MMBTU. It was the lowest close in over 2 years, since August 11, 2016. Since reaching $3.48/MMBTU on January 21, prices are down 27% in less than 3 weeks. Additionally, prices are down 48% from the November intra-session high of $4.90/MMBTU. With the sell-off, natural gas pries have returned to a state of contango for each of the next 6 months for the first time this winter, as shown in the Figure to the right. Contango is the structure in which subsequent futures contracts are more expensive than the previous month's contract. This has important implications for ETF traders as, over time, contango places an added drag on ETF performance due to a sell-low-and-buy-high monthly rollover. Fortunately, the contango right now is relatively small, averaging just 1.2% per month. Additionally, natural gas prices are now below $3.00/MMBTU for each futures contract for the next 3+ years with the exception of the January 2020 contract, which settled at $3.03/MMBTU.

While the EIA's smaller-than-expected storage withdrawal likely contributed to the sell-off, the primary driver was a bearish turn in the 44-day ECMWF-EPS which trended much warmer for the February 14-18 period. The model's most recent Thursday run re-intensifies the ridge across the East allowing warm air to return northwards, significantly cutting heating demand across these major population centers. Investors seemed to ignore the fact that the model trended colder for the last few days of February and first week of March such that the overall change from Monday's run was relatively minor. As a result, my Hybrid Model--which integrates data from the near-term GFS and ECMWF ENS and long-term ECMWF-EPS and CFSv2 models--now shows a brief period of below-average daily gas-weighted degree days (GWDDs) for February 15-17 followed by a rapid return to above-average forecast GWDDs for the next 3+ weeks as the eastern ridge is finally broken down for an extended period. Click HERE for more on the near- and long-term forecast on my Advanced Models Page. In my opinion, natural gas has become overwhelmed by bearish sentiment and is disconnected from its fundamentals. Investors just used the moderation in this model as an excuse to sell, rather than a decision based on sound fundamentals. As mentioned above, natural gas prices are at a more than two year low. This is rather remarkable given that on August 11, 2016 when prices were last at $2.55/MMBTU, natural gas inventories were at a +405 BCF storage surplus versus the 5-year average compared to the current Realtime -331 BCF storage deficit, a 736 BCF difference versus the 5-year average at two equal price points. Taking a similar approach but looking at more data points, my Natural Gas Fair Price model is now calculating that the commodity is trading at a 34% undervaluation versus a Fair Price of $3.86/MMBTU based on Realtime inventories alone. Additionally, despite the mid-February warming trend in the models, the overall forecast remains generally favorable into early March as discussed above. The storage deficit versus the 5-year average could still top -500 BCF and I am currently projecting that season-ending inventories will bottom out near 1225 BCF, the second smallest in the last 5 years. This pushes the Fair Price to $4.00/MMBTU and the undervaluation to 36%, one of the largest ever recorded by my model. Even with a modestly loose supply/demand imbalance, prices under $2.75/MMBTU are not justified and should likely be higher than that. Despite the sell-off and model trends, I am not changing my price target, keeping it at $3.00/MMBTU before the end of the withdrawal season. Natural gas is priced for imperfection right now. A continuous supply of bearish headlines is needed to maintain prices this low. At some point, I expect a violent bounce as the models cool or some other fundamental change takes place and bullish investors jump back in and rapidly re-value the commodity. Stay tuned and be careful. I believe that the best approach is to maintain a small long position or to wait on the sidelines. Holding a sizable short position here is extremely risky because, even as the commodity may still dip slightly more near-term, the magnitude of potential upside dramatically outweighs the magnitude of downside risk.

Meanwhile, crude oil suffered a sell-off of its own on Thursday. WTI prices tumbled $1.37 or 2.5% to $52.64/barrel while Brent fell $1.06 or 1.7% to $61.63/barrel. The sell-off was likely multifactorial, driven by profit-taking, a rising US dollar, the ever-present global demand fears, as well as news that Libyan forces had retaken a key oil field and that production could restart there soon. After Wednesday's bullish EIA Petroleum Status Report, my sentiment towards oil has improved and I feel that a sell-off is below $53/barrel is a good long-term buying opportunity. It is for this reason that I covered my small UWT short position Thursday morning for a +10% profit and promptly shorted a 3.4% position in DWT, providing long exposure. Should WTI trade under $52/barrel and then under $50/barrel, I will looking to make sequential small additions to my short position, targeting a maximum position size of 10%.According to my Fair Price model, based on current inventories, the commodity is undervalued by a substantial 14% versus a Fair Price of $60.56/barrel. For this reason, my 2019 price target for WTI remains $60/barrel, and this could end up being conservative.

After 5 straight days of exceptionally bearish -10 BCF/day or smaller daily storage withdrawals, natural gas demand will soar today as much colder temperatures finally make their way into the Deep South and nearly to the Eastern Seaboard. Highs in Dallas will be only in the low 40s today, 30 degrees colder than the past three days and 15F below-average. Further east, Chicago will only reach the lower teens while Indianapolis targets 20F, both 15F-20F colder-than-average. After dropping to -10F overnight, Minneapolis will likely not even reach 0F today, nearly 30F colder-than-normal. The arctic cold front responsible for this cooldown will not quite make it off the eastern seaboard today and, as a result, coastal cities will have one more day of unseasonable warmth. Raleigh and Charlotte in North Carolina will reach the low 70s, Washington, DC and Philadelphia the low 60s, and New York City and Boston the mid 50s, all 15F-20F warmer-than-normal. This will change abruptly tomorrow. Across the Pacific Northwest, today will begin a multi-day snowfall even for Seattle and Portland where up to a foot total could fall across the former with temperatures 15F-20F below-average in the low 30s. Despite the eastern warmth, the rapid expansion of arctic air southward and eastward will result in today's mean population-weighted nationwide temperature tumbling a dramatic 8.2F from Thursday to just 41.2F, within 0.2F of normal. Forecast Total Degree Days (TDDs) will soar to 25.0 TDDs, 0.5 TDDs greater than normal and the 17th most for February 8 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 -26 BCF/day daily natural gas storage withdrawal, 16 BCF larger than Thursday and 3 BCF bullish versus the 5-year average, the first and only bullish daily storage withdrawal this week. Click HERE for more on today's forecast daily storage withdrawal and Realtime natural gas inventories. Overall, for the storage week of February 2-8 that ends today, I am projecting a preliminary -78 BCF weekly withdrawal. Thanks to record-setting mid-week warmth, such a draw would be 82 BCF bearish versus the 5-year average and 105 BCF smaller than last year's draw. The draw would also be a massive 159 BCF smaller than the previous week's -237 BCF withdrawal thanks to mean nationwide temperatures this week averaging 47.1F, an incredible 11.8F week-over-week warm-up. Should a -78 BCF withdrawal verify, natural gas inventories would fall to 1882 BCF while the storage deficit versus the 5-year average would contract sharply to -333 BCF. The year-over-year deficit would narrow to a mere -33 BCF. The EIA will release its official storage numbers for the week next Thursday, February 14, at 10:30 AM EDT. Click HERE for more on the week's projected draw.

Looking ahead to next week's demand outlook, it is safe to say that the storage deficit versus both the 5-year average and 2018 bottomed at least temporarily on Friday. As the previously-discussed arctic cold front clears the East Coast, Saturday could see the largest daily storage withdrawal for the remainder of the heating season at an exceptionally bullish -37 BCF/day, 16 BCF bullish versus the 5-year average -21 BCF/day draw. Once again, however, the cold air won't stick around and demand will fall back below-average by Tuesday before stabilizing right near the 5-year average as above-average temperatures return to the Eastern Seaboard but are countered by persistently colder-than-average temperatures across the Rockies and Plains. Projected daily natural gas storage withdrawals are shown in the Figure to the right. At this time, I am projecting a -167 BCF weekly storage withdrawal, 16 BCF bullish versus the 5-year average and 30 BCF larger than last year's -134 BCF withdrawal. It would be the second largest for the week in the last 5 years, behind only 2014's -227 BCF withdrawal. Inventories would fall to 1714 BCF while the storage deficit versus the 5-year average would rebound to -354 BCF. The EIA will release its official storage numbers for the week on Thursday, February 21, at 10:30 AM EDT. I will have much more on next week's storage picture in Monday's commentary, but in the meantime click HERE for more.