July 11, 2019

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Crude Oil Tops $60/Barrel After The EIA Reports Bullish & Larger Than Expected -9.5 MMbbl Inventory Draw; EIA Forecast To Announce 17th Straight Bearish Natural Gas Build Today; Developing Tropical Storm Shuts In Gulf Of Mexico Oil & Natural Gas Production But Don't Get Swept Up In The Hurricane Trade--Unless You Are Looking For A Sell-The-News Opportunity

6:00 AM EDT, Thursday, July 11, 2019
In its weekly Petroleum Status Report covering June 29-July 5, the EIA announced Wednesday morning that crude oil inventories fell by -9.5 MMbbls. This was double the 5-year average -4.9 MMbbl draw and was larger than the American Petroleum Institute's already-bullish -8.1 MMbbl forecast drawdown. It was the third largest draw on record for the June 29-July 5 period since 1983, behind only 2013's -10.0 MMbbl and last year's -12.7 MMbbl declines. With the draw, crude oil inventories fell to 459.0 MMbbls, which is the lowest since April 12. As the Figure to the right shows, crude oil inventories steadily rose throughout April and May, peaking at over 485 MMbbl, leading to WTI crashing from $65/barrel to just over $50/barrel. Since then, however, storage levels have fallen each of the past 3 weeks, dropping more than 22 MMbbls in that span, resulting in the storage surplus versus the 5-year average contracting by over 25% to +23.2 MMbbls. And with the supply/demand imbalance averaging -3.6 MMbbls/week over the past month, I project that inventories could continue to fall, dropping as low as 380 BCF by the end of 2019, restoring a storage deficit versus both the 5-year average and 2018.

Perhaps the most noteworthy thing about the Status Report--besides the large draw--was the transition from a positive Adjustment Factor to a negative Adjustment Factor. The Adjustment Factor is the EIA's way of squaring discrepancies between its storage data (considered more accurate) with its supply/demand data (considered more preliminary). For weeks, the EIA has reported historically high Adjustment Factors of 0.6-0.8 MMbbls/day, meaning that supply was underestimated and/or demand was overestimated. That changed this week with a -0.47 MMbbl/day adjustment. This suggests that either exports--which averaged a so-so 3.0 MMbbls/day last week--were underestimated or imports--a relatively robust 7.3 MMbbls/day--were overestimated. I view this as a bullish trend and expect the tight supply/demand imbalance to continue.

Investors agree. After trading up 2% in anticipation of the EIA's bullish numbers, WTI continued to rally after the report and settled up a huge $2.60 or 4.5% to $60.43/barrel. It was the fifth straight gain for the commodity--the longest streak since February--and was the highest close since May 22. Brent finished up $2.85 to $67.01/barrel. While the storage numbers were obviously the primary driver, the developing Gulf of Mexico tropical system that is likely to become Tropical Storm or Hurricane Barry may have also played a role. However, as I've discussed previously, I believe such buying would be erroneous. While the system has already shut-in 32% of Gulf production--or a solid 0.603 MMbbls/day--such disruptions are likely to be short-lived as Barry is unlikely to become more than a Category 1 storm. Additionally, the storm is also likely to impact elements of oil demand, namely refinery inputs and exports, which could more than counter losses in production. For this reason, I would not be surprised to see a sell-the-news event once the storm passes. Nonetheless, the large draws in recent weeks have dramatically improved the fundamental outlook for crude oil. Following Wednesday's big rally, WTI has now nearly reached its Fair Price based on current inventories alone, which stands at $60.88/barrel. However, thanks to the much tighter supply/demand balance, the projected Fair Price reaches $70/barrel by the end of the year as inventories fall under 400 MMbbls, as shown in the Figure to the right. For this reason, I remain bullish on the oil sector. However, I am maintaining my upside WTI price target of $65/barrel at this time rather than upping it to $70/barrel. I feel that, above $65/barrel, there may be some demand destruction, drilling will increase, OPEC will be more likely to bolster output quotas, and Donald Trump will start tweeting about "high" oil prices again.

Meanwhile, natural gas prices also rallied on Wednesday. The August front-month contract neared $2.50/MMBTU early in the session before settling up a more modest 2 cents or 0.8% to $2.44/MMBTU. It is not immediately obvious what the primary driver of the gains were. If anything, the near-term temperature outlook--especially the 14-day GFS ENS--cooled slightly, as shown in the Figure to the right. Despite the cooling trend, both the GFS ENS and ECMWF ENS are forecasting 14-day accumulated gas-weighted degree days (GWDDs) that are comfortably above-normal and it is certainly possible that investors are still reacting to this pattern shift. But once again, it is also possible that investors are (erroneously, in my opinion) bidding up the commodity in anticipation of supply disruptions caused by soon-to-be Barry. As of Wednesday evening, just 18% or 0.5 BCF/day of production had been shut in. While it is likely that this number goes up, it is unlikely to exceed 2 BCF/day, a level that I expect will be more than cancelled out by demand losses due to reduced Powerburn and LNG export disruptions from Sabine Pass and Cameron, whose capacity together alone is over 4.5 BCF/day. At this time, I am maintaining my $2.60/MMBTU summer price target--which is in-line with my Fair Price Model--though I may even consider throwing on a quick short position should the commodity spike in what I interpret to be a hurricane-induced manner.

Meanwhile, my Oil & Natural Gas Portfolio rose to a new 2019 year-to-date high for the third time in the last four sessions, driven by the surge in oil prices. The Portfolio finished at session highs, up +1.0% to push 2019 year-to-date gains through the first 131 trading days to +15.6%, or +30.0% annualized. I made no trades on the day. With oil topping $60/barrel, my WTI long position via short DWT has continued to shrink, falling to just 3.6%, my second smallest position. The trade is up +27.3% from my basis. I have no intention to rebuild this position at such lofty levels and will still plan to cover the entirety should WTI top $65/barrel. Whether I then immediately go short is still to be determined. My natural gas long exposure is likewise declining and now stands at just 6.0% via partially offsetting DGAZ and UGAZ short positions, down from over 10% 2 weeks ago. While my upside price target is $2.60/MMBTU and I remain long-term bullish, should natural gas continue to spike near-term as a result of Barry, I will consider swinging transiently to short--likely by boosting UGAZ short exposure or even via a bulky 30% short UNG short to capitalize on the inevitable sell-the-news event. Overall, however, I am not going to sweat short term moves. I will not panic at pullbacks after the recent runs in both commodities and will exercise patience and restraint. Long-term, leverage-induced decay will continue to hammer at both oil and natural gas ETFs and all I need to do is hang on. Click HERE for more on my current oil and natural gas holdings.

The EIA will release its weekly Natural Gas Storage Report for the week of June 29-July 5 this morning at 10:30 AM EDT. I am projecting a +75 BCF storage injection which represents a significant upward revision from previous projections and would no longer be sufficient to snap the streak of 16 straight bearish reports, coming in at 4 BCF larger than the 5-year average. The upward revision was due to larger-than-expected finalized pipeline data. As the Figure to the right shows, such a build would be the third largest in the past 5 years. Should a +75 BCF injection verify, natural gas inventories would rise to 2465 BCF while the storage deficit versus the 5-year average would contract to -148 BCF. Click HERE for more on last week's projected injection.

With a largely neutral report and investors likely more focused on the tropics and the potential for mid-July heat, I would not be surprised to see today's Report slide under the radar, unless it comes in much higher or lower than expected. I feel that it would take a reported injection of +85 BCF to be considered unequivocally bearish versus expectations with prices falling back under $2.40/MMBTU. Likewise, it would take an injection of under +65 BCF to be considered bullish and sufficient to stimulate enough buying for the commodity to top $2.50/MMBTU. A reported build between +65 BCF and +85 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 fall today as temperatures cool across the Central US and Southeast as Barry begins to influence coastal temperatures. The large expanse of Heat Advisories from Wednesday has shrunk to cover a small area of northern Louisiana, northern Mississippi, and northern Alabama where highs could reach the mid-90s, around 5F warmer-than-normal. Elsewhere, highs across the region will cool to within 5F of normal while the immediate Gulf Coast, including New Orleans, LA and Mobile, AL, will be around 5F cooler-than-normal. Along the Atlantic Seaboard, highs will be seasonally warm in the mid-to-upper 80s from Washington, DC to New York City. Temperatures will warm significantly across the Intermountain West with Phoenix, AZ topping 112F, Salt Lake City approaching 100F, Denver the mid-90s, and even Boise, Id into the low 90s, all 5F-10F hotter-than-normal. However, the airmass that had until today brought cool readings to the Rockies, will shift into the Great Plains with St Louis only reaching the low 80s, Chicago--one day removed from seeing the mid-90s--approaching 80F, and Milwaukee, WI only in the lower 70s, all 10F cooler-than-normal. Overall, today's forecast mean population-weighted nationwide temperature will cool 0.6F from Wednesday to 78.3F, still 0.9F warmer-than-normal. Total Degree Days (TDDs) will fall to 13.6 TDDs, the 10th most TDDs for July 11. Click HERE for more on today's forecast temperatures and Realtime natural gas inventories. Based on this forecast and early-cycle pipeline data, I am projecting a +9 BCF/day daily natural gas storage injection for today, 1 BCF larger than Wednesday, but still 1 BCF smaller than the 5-year average +10 BCF/day build. By tonight, look for Realtime natural gas inventories to reach 2522 BCF while the storage deficit versus the 5-year average inches higher to -148 BCF. Click HERE for more on today's projected daily injection and Realtime natural gas inventoreis.

For a storm that (as of Wednesday evening), hadn't even been named, proto-Barry has been making headlines. As of 11 pm, the system was a well-defined swirl south of New Orleans and was very close to becoming a Tropical Depression or Tropical Storm--and may very well be by the time you read this. While the system was impacted Wednesday by some modest northerly sheer, atmospheric conditions are expected to become more favorable and the NHC is still forecasting that it will make landfall as a Category 1 hurricane. The most significant change over the last 24 hours has been a contraction in the forecast cone, trending eastward zeroing in on a central Louisiana landfall, increasing the threat to New Orleans. This is good news for the Sabine Pass LNG export plant, located on the Texas/Louisiana border, as it places the system on its weaker--both rainfall- and wind-wise--western side. While the plant could still see disrupted tanker traffic, it looks increasingly less likely that the area will take a direct hit that could take the facility offline for an extended period. The Cameron LNG plant--currently exporting around 0.6 BCF/day--will be closer to the center of the storm, but still looks to escape the heaviest of the rain, although some flooding at the facility cannot be ruled out. Indeed, flooding rains at and to the east of where the center makes landfall will be the biggest threat from Barry with most models forecasting totals in the 10"-25" range. As discussed above, 18% of natural gas production and 32% of oil production in the Gulf of Mexico has been shut in and while these numbers could very well go higher, any disruptions are likely to be temporary. Once again, this is not a good set-up to go long expecting a sustained rally. If anything, it could present a short-term, swing trade a sell-the-news opportunity for both commodities. Click HERE for more on the NHC's latest on Barry.