December 31, 2019

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It’s A Waiting Game In The Natural Gas Sector As Fundamentals Continue To Improve But Temperature Outlook Remains Bearish; Gas Demand To Rise Sharply Today As Temperatures Moderate, But Bearish Draw Still Expected As New Storage Surplus Grows

6:00 AM EDT, Tuesday, December 31, 2019
In its first day as the Front Month Contract, the February 2020 contract left off right where the January contract had expired: in the red. The commodity dipped 4 cents or 2.0% to settle at $2.19/MMBTU. The commodity quickly gave up slight overnight gains as morning and afternoon computer runs trended considerably milder for January. It is becoming increasingly likely that a deep trough across Alaska and parts of the West will keep a ridge of high pressure in place across the populous East allowing mild temperatures to persist. A quick shot of cooling in the January 6-8 timeframe looks now to be fleeting. Meanwhile, oil prices snapped a 4-session winning streak as profit-takers stepped in. WTI inched lower by 4 cents or 0.1% to settle at $61.68/barrel while Brent dipped 20 cents to $66.67/barrel. Nonetheless, WTI is just below a 3-month high and prices are up 11.8% this month alone and 36% year-to-date . While fundamentals have improved with inventory drawdowns each of the past two weeks amidst rising refinery demand, the commodity is overbought and a near-term pullback would not be surprising. Finally, my Oil and Natural Gas Portfolio retreated from Friday’s year-to-date high, falling -0.5% to reduce 2019 gains to +17.0% with just 1 trading day left in the year. I made no trades on the day. Natural gas investors face quite the quandary heading into 2020. On the one hand, the temperature outlook for at least the next two weeks looks quite bearish, no two ways about it. As stubborn pattern will favor ridging over the eastern US, effectively locking this region out from exposure to arctic air. As the Figure to the right shows, consensus model–based on performance-weighting of GFS ENS, GFS OP, ECMWF ENS, CFS, and ECMWF-EPS models–now expects only a quick shot of above-average gas-weighted degree days (GWDDs) over the next two weeks before temperature-dependent demand quickly drops back to below normal. Even longer-term, the CFS and ECMWF EPS are calling for generally seasonal to below-average GWDDs. As a result, forecast GWDDs for the near term day 1-14 period are the second fewest in the last 5 years (behind only 2018) and the ninth fewest for the full 39 year period since 1981. And for the 6-week day 1-44 period, forecast GWDDs are again the second fewest in the past five years and the 11th fewest in the past 39 years. Historically, this type of sustained mid-winter warmth has resulted in abrupt sell-offs to under $2.00/MMBTU.

However, this bearishness must be placed in the context of overall natural gas fundamentals. After 6 weeks at a storage deficit versus the 5-year average, inventories flipped back to a surplus Monday morning. Over the next 4 weeks, this surplus could grow to around +135 BCF, a 52-week high. As a result, my projected Fair Price will fall from its current $2.58/MMBTU to $2.43/MMBTU, still a 10% undervaluation. Despite this near-term bearishness, long-term fundamentals continue to improve as the natural gas supply/demand imbalance continues to tighten. As I discussed in Monday’s commentary, the temperature-independent supply/demand imbalance continues to tighten with the year-over-year imbalance contracting from -2.5 BCF/day loose in early November to just 0.5 BCF/day loose last week, and likely flipping to tight versus 2019 in the next 1-2 weeks. Additionally, the imbalance versus the 5-year average has contracted 3.2 BCF/day loose to 1.8 BCF/day loose. This contraction has been driven by 3 factors. First, persistently discount natural gas has driven fuel switching to natural gas with Powerburn demand averaging 1.5 BCF/day higher year-over-year over the past 12 weeks. Second, LNG feedgas demand has soared to record highs, reaching 8 BCF/day, up a massive 3.6 BCF/day from 2018. And finally, and most importantly, after roaring higher throughout the year, natural gas production finally appears to have peaked (for now) and is even downtrending. The EIA won’t release official production data until January 9, but I publish daily projected production data. Per this data, output is averaging 95.3 BCF/day over the past week, down 1.5 BCF/day from the 96.8 BCF/day peak from mid-November. Long-term, I expect these three trends to contribute to further tightening which should provide further support to natural gas. However, this time of year, investors tend to neglect fundamentals in favor of the temperature outlook which, as discussed, is highly unfavorable. For this reason, it will be very difficult for natural gas to mount a sustained rally and I would not be surprised to see further near-term weakness, potentially as low as $2.00/MMBTU. Out of respect for my Fair Price Model, I am reducing my upside price target to $2.40/MMBTU from $2.50/MMBTU. However, the commodity is very susceptible to a short squeeze should the temperature outlook flip to colder-than-normal and, at this time, I am not considering going short. Long-term, my strategy of shorting the inverse 3x ETF (in this case DGAZ) to capitalize on both directional movement and leverage-induced ETF will likely pay dividends.

Natural gas demand will rise sharply for a second straight day today as more seasonal temperatures return to the Central US. Minneapolis, MN will be very close to average in the mid-20s as will Chicago near the 32F mark. Kansas City, MO will approach 40F while Des Moines, IA will see the mid-30s, both around 5F warmer-than-normal. Warmer-than-normal temperatures will persist across the East, however, with Washington, DC seeing the mid 50s, Philadelphia, PA the low 50s, and New York and Boston near 50F, all 10F-15F warmer-than-normal, but around 10F cooler than Monday. The warmth will extend southward with Richmond, VA seeing the low 60s, a springlike nearly 20F warmer-than-normal . Nonetheless, due to the cooldown across the Central and Eastern US, today’s forecast mean population-weighted nationwide temperature will fall 4.9F from Monday to 43.9F, halving the warmer-than-normal anomaly to +4.6F. Total Degree Days (TDDs) will rise to 21.0 TDDs, still 5.3 TDDs fewer than normal and the 14th fewest for December 31. Click HERE for more on today’s temperature and degree day outlook.

Base on this forecast and early-cycle pipeline data, I am projecting a -17 BCF/day daily natural gas storage withdrawal, 6 BCF larger than Monday’s draw but still 10 BCF bearish versus the 5-year average -27 BCF/day. By tonight, projected Realtime natural gas inventories will fall to 3153 BCF while the new storage surplus versus the 5-year average will build to +26 BCF. The year-over-year surplus, on the other hand, will contract by 4 BCF to +488 BCF. Click HERE for more on today’s projected daily storage withdrawal and Realtime natural gas inventories.