While longer term supply and demand dynamics are important in the price movements of natural gas, in the short term weather is often the most important variable in determining price. Last winter the period between December and February was the fourth warmest on record. Then March became the warmest March on record in the lower 48 Contiguous United States (CONUS). The warm start to December have many predicting a repeat of last year. But according to the latest prediction from the National Oceanic and Atmospheric Administration (NOAA), the warm pattern may be about to change. The CFS version 2 was developed at the Environmental Modeling Center and is a fully coupled model representing the interaction between the Earth's oceans, land and atmosphere. It became operational by the NOAA in March 2011, so it doesn't have a long term track record. Here is the model's latest prediction for the first two weeks in January and the whole month of January:
Unlike last year at this time, there is very cold air far north of the Canadian border and in Alaska. The normal high temperature for Fairbanks Alaska on December 16 is 5 degrees Fahrenheit. Yesterday, the actual high temperature for Fairbanks was -37 degrees Fahrenheit, which is 42 degrees below normal. Cold air is available to come into the CONUS if the right steering patterns emerge. That is what the CFSv2 model is attempting to predict.
Many natural gas investors rely on the NOAA 6-10 Day Outlook and the 8-14 Day Outlook to determine where the weather is going.
If the CFSv2 model is correct, then before the end of the year the NOAA 6-10 Day and 8-14 Day Outlooks will look very cold for the first two weeks of January. This would spark a rally in natural gas prices.
According to the EIA Weekly Natural Gas Report, the slow start to the winter has pushed natural gas storage back to a surplus over last year's storage level by 48 Bcf, and by 283 Bcf above the closely watched 5 year average. The weather pattern predicted by the CFSv2 model for January would create a large amount of Heating Degree Days (HDD) and would quickly close the storage surplus versus not only last year, but also versus the 5 year average. The NOAA National Climatic Data Center ranks January 2012 as the warmest January on record over the last 115 years. While they list January of 2011 as a somewhat below normal month, they list January 2008, 2009, and 2010 as normal. A much colder than normal January 2013, as currently predicted by the CFSv2 model, would rapidly close the storage deficit versus last year and the slightly warmer than normal 5 year average. This could easily spark a rally above $4 per mcf in natural gas in order to end all of the coal to gas switching by power companies as it would no longer be needed.
One way to take advantage of the current climate prediction model for January is to buy the United States Natural Gas Fund (UNG) for direct exposure to natural gas. Another way is to purchase one or more of several beaten down natural gas producers like Chesapeake Energy (CHK), Ultra Petroleum (UPL), Apache (APA), Devon Energy (DVN), or Magnum Hunter Resources (MHR).
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.