October 21, 2019

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Winter Is Coming And The Shorts Have Overextended Themselves--So Why Is Natural Gas Not Rallying? Oil Likely To Trade Laterally As Demand Concerns To Be Countered By A Resumption Of Inventory Drawdowns; Gas Demand To Bottom Today With Ugly +16 BCF Injection With Steady Rebound Expected Through Week's End As Colder Air Filters South

6:00 AM EDT, Monday, October 21, 2019
Natural gas rallied on Friday to wrap up the week on a strong note and rebound from the previous week's losses. The November 2019 front-month contract finished with only a 0.1% daily gain to $2.32/MMBTU--but still capped a 4.8% weekly rally--while the December contract, into which the 3x ETF, UGAZ, has rolled all of its funds and the 1x ETF, UNG, 75% of its funds, ended up a stronger 1% to $2.52/MMBTU. Despite the weekly rally, front-month natural gas prices are down a steep 29% from 2018 when they were trading at $3.25/MMBTU and were poised to make a run to nearly $5.00/MMBTU in the coming month. The rally in natural gas last week came despite the EIA reporting a very bearish +104 BCF storage injection (the third triple digit build in the past 4 weeks), production topping 94 BCF/day for the first time, and the temperature-independent supply/demand imbalance loosening to a 14-week low. On the other hand, the commodity found support in what is increasingly likely to be an impressive early-season arctic outbreak during the final days of October into early November. Both the GFS ENS and ECMWF ENS agree that a prolonged period of much below-average temperatures will dominate the lower 48, though the GFS remains considerably colder. Over the weekend, both models remained cold for the 14-day period, though both models moderated somewhat late on Sunday. Additionally, Thursday's run of the 6-week ECMWF-EPS long-term model trended sharply colder as well, hinting that below-average temperatures could persist well into November, though the CFSv2 model continues to support warmer-than-average temperatures by the second week of the month. Click HERE for more on the near- and long-term temperature outlook on my Advanced Modeling Page. As a result of this cooldown, my end-of season projected inventories have fallen by nearly 100 BCF over the past two weeks to around 3775 BCF. This would be the third smallest in the last five years, behind 2018's 3247 BCF and 2014's 3611 BCF, but would still be up a massive +527 BCF year-over-year and +44 BCF versus the 5-year average.

On Friday, the Commodity Futures and Trading Commission released its weekly report detailing money manager natural gas holdings on the NYME through Tuesday, October 15. Despite the rally in prices, natural gas investor sentiment continues to weaken--which seems hard to believe, as low as it already was. Open long positions inched lower by 488 contracts to 105,241 contracts--a new 52-week low--while short holdings soared by 26,385 contracts to 301,579 contracts. Shorts are up a remarkable 244,065 contracts or 424% from this time last year. As the Figure to the right shows, the bears have recovered nearly 3/4 of September's short-covering rally, with the late-August 52-high mark at 367,343. Further, buyers did not really participate in the at rally and open long positions have continued to bleed lower since. As a result, the Bullish Sentiment--the percentage of open positions held long--slumped to just 26%. This is now the lowest Sentiment since at least 2013 and is down a whopping 58% from 2019 when Sentiment was over 80%. It is also down 32% from the 52-week average of 58%. By any metric, this suggests a severely overcrowded short trade. Click HERE for more on the latest CFTC-reported natural gas money manager holdings.

The combination of a severely overcowded short trade and an upcoming early-season arctic outbreak would typically be the recipe for a short squeeze higher. We saw this last year when prices spiked 73% from $2.75/MMBTU on September 14 to $4.75/MMBTU on November 26 thanks to a sustained early-November shot of arctic air. The big difference between 2018 and 2019 is that inventories were struggling to top 3200 BCF last year and many analysts, including yours truly, were projecting that storage levels would fall below 1000 BCF by the end of the withdrawal season, raising fears of a storage crunch. This year, however, inventories are more than 500 BCF higher and the supply/demand imbalance is even looser thanks to record production. Investors realize that storage levels are more than plentiful this year. While natural gas demand will spike next week, the bulls have come to understand that short-sellers will merely use any price spike to simply reload their positions at a better entrypoint and have been reluctant to buy. Without any true fear in the market, there is little to sustain any gains. According to my Fair Price model, natural gas is sharply undervalued by 8.5% versus a Fair Price of $2.53/MMBTU. But with ample supplies and a large contango heading into the winter months, the commodity quickly becomes overvalued, as shown in the Figure to the right. For the full 8-month period for which I issue projections, natural gas is overvalued by 2.3%. What does this mean for natural gas? It means a particularly challenging trading environment for traders. Despite the seemingly bullish near-term combination of large short imbalance and favorable temperature outlook, it is tough to justify buying here as I feel that, for now, any upside will be limited and will only be short-term. Should December prices top $2.60/MMBTU, I expect that short-sellers will be jumping back in head first, and I would not be surprised to see December 2019 prices fall under $2.25/MMBTU should November verify as above-average, as forecast by the CVSv2. On the other hand, I can't ignore the huge short imbalance, as discussed above. This makes holding onto a large short position a risky endeavor. While it is likely that prices will continue to fall, should something unexpected happen to dramatically revise sentiment--be it meteorological, geopolitical, or an act of God--the bears could be quickly victimized by an enormous short squeeze. For this reason, I cannot justify going short at these levels. For the time being, I expect to see rangebound trading with weather-driven attempts by the bulls to drive prices above $2.50/MMBTU met with aggressive selling and prices dipping back under $2.30/MMBTU. In conclusion, natural gas may look cheap, but it really isn't. Long-term, once supply and demand rebalance, the sector will be ripe for a sustained move higher, but that time is not now.

Meanwhile, oil prices finished lower on Friday, building on a weekly loss, as building domestic inventories and ongoing concerns over global supply and demand weighed on sentiment. WTI fell 15 cents or 0.3% to settle at $53.78/barrel while Brent dipped 49 cents to $59.42/barrel. For the week, WTI lost a modest 1.7%. On Friday, China announced slower-than-expected GDP growth of just 6% in the third quarter, the weakest pace in 27 years, suggesting that the US-China trade war is negatively impacting the Chinese economy. Additionally, the EIA announced Thursday morning that US crude oil inventories rose by a huge +9.3 MMbbls, the fifth straight weekly gain. And on Friday, Baker Hughes reported that the oil rig count rose by +1 rigs to 713, the second straight weekly rise and first two-week winning streak since February 15, 2019. Nonetheless, natural gas rigs fell by 6 meaning that the total rig count was down 1 on the week. I suspect that the decline will be temporary with producers continuing to cut capex budgets and current prices not supporting aggressive drilling. I likewise expect inventories to begin falling sharply with a surge in exports and slump in imports still expected, at roughly the same time refinery demand begins to recover from a slew of outages. Thus, despite weak sentiment presently, I am not abandoning my long trade and am not reducing my $65/barrel upside price target. Near-term, however, I do expect investors to remain pre-occupied with global demand and feel that, for a period of time, this concern will counter falling inventories and could keep the commodity rangebound between $52/barrel and $55/barrel.

Over the weekend, natural gas demand fell as temperatures warmed across the Great Lakes and heavy rain along the major population centers of the Eastern Seaboard capped both heating and cooling demand. Daily natural gas storage injections rose from +12 BCF/day on Saturday to +14 BCF/day on Sunday, both modestly bearish versus the 5-year average +9 BCF/day. Gas demand will fall further today as temperatures warm further across the Northeast. Highs will reach the mid-60s in Boston and the upper 60s further south down I-95 towards Philadelphia and Washington, DC, around 5F warmer-than-normal. The anomalies will be even larger across the interior with Buffalo, NY approaching 70F and Columbus, OH reaching the low-to-mid 70s, each over 10F warmer-than-normal. The warmth will extend westward with Detroit, MI reaching the upper 60s, Chicago, Il the mid-60s and Minneapolis, MN near 60F, all around 5F warmer-than-normal. On the other hand, below-average temperatures will begin to build across the Intermountain West and the Great Plains with Omaha, NE and Denver, CO only seeing the low-to-mid 50s, 5F-10F below-average with much cooler temperatures still to come. Overall, today's forecast mean population-weighted nationwide temperature will rise by 1.5F to a balmy 63.0F, 4.1F warmer-than-normal. Total Degree Days (TDDs) will fall to 7.3 TDDs, 2.0 TDDs fewer than normal and the 11th fewest for October 21 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 +16 BCF/day daily natural gas storage injection, 2 BCF larger than Sunday's build and an ugly 7 BCF bearish versus the 5-year average +9 BCF/day. With much cooler temperatures arriving towards the end of the week, it is likely that today's injection will be a peak for the remainder of the Shoulder Season. By tonight, projected Realtime natural gas inventories will reach 3650 BCF while the storage surplus versus the 5-year average will top +43 BCF. The year-over-year surplus, meanwhile will climb to +541 BCF. Click HERE for more on today's projected daily storage injection and Realtime natural gas inventories.

For the remainder of the week, natural gas demand will steadily rise as the below-average temperatures across the Rockies and Plains today expand and intensify. As the Figure to the right shows, by Friday, the daily storage injection could fall to +9 BCF/day, or very close to the 5 year average. Nonetheless, due to early-week warmth, I am still projection a very bearish +88 BCF storage injection for October 19-25. This would be 23 BCF larger than the 5-year average and a huge 39 BCF greater than last year's +49 BCF injection. It would be the single largest injection in the last 5-years--last year's +49 BCF build was the smallest--as well as the single largest all-time for October 19-25 dating back to 1994. Of note, 2006 saw a -1 BCF storage withdrawal for the week, the earliest date for a draw during the shoulder season. As bearish as my current +88 BCF is, it is considerably lower than it was earlier when I was projecting as high as a +104 BCF build for the week on October 9, back when there was no sign of the late week cooldown. Should a +88 BCF injection verify, natural gas inventories would rise to 3696 BCF while the storage surplus versus the 5-year average would climb to +53 BCF and the year-over-year surplus would reach +560 BCF. The EIA will release its official storage injection for the week on Thursday, October 31 at 10:30 AM EDT. Click HERE for more on this week's projected injection.