Natural gas (NYSEARCA:UNG) prices were up 3.53% for this week.
Recent short-term price spikes are definitely not attributed to near-term fundamentals. Heating demand is forecasted to remain below the five-year average for all of October, but injection estimates are still below the average thanks to the structural tightening we've highlighted. As heating season starts, natural gas storage will face a very gloomy future in March and April of 2017. A supply response is needed, and we think it will come when gas prices hit $4. For the time being however, traders we talk to can't seem to get over the fact that we could be 500 Bcf below the five-year average come April 2017. Most of them have not turned bullish yet, and some remain skeptical pointing to short-term bearish signals like slower heating start and higher storage. But we cautioned that level of thinking last week as traders have to balance the short-term with the medium-term outlook.
Looking at the price action this week, it's now very evident to us that fear of missing out (FOMO) is firmly in place. The storage report this week was a catch-up report from the previous week's overstated injection figure. The price action surprised us a bit as we somewhat expected a downward bias revision, but the market certainly didn't expect it.
We think the current sentiment is that producers will somehow quickly ramp up natural gas production, but we caution that level of thinking. First, Canadian natural gas producers as a whole will barely keep production flat next year as most of the big operators switch to liquid rich plays. Second, Marcellus pipeline takeaway constraints will limit what has been the biggest supply growth in the US. Lastly, if you look at capex guidance, most producers are still using DUCs next year, and very few are actually expanding outside of the proven basins. This signals to us that higher prices will only result in moderate supply growth, and we suspect $4+ gas is needed for an extended period of time for US to catch up to the current deficit.
We will be releasing a "Big Picture Outlook" piece this Sunday to premium subscribers on why we think Canadian natural gas producers will benefit the most from the next leg up in natural gas prices. Fund managers have largely focused on Marcellus producers as they have the lowest breakeven, and we think Canadian natural gas producers have been neglected. Fund flows and better investor sentiment will see the big 30% valuation difference close, and we see this as a very non-consensus trade.
Overall, FOMO is usually the psychological phenomenon you see at the end of a recent price cycle. While fundamentally speaking, gas prices have much more potential to move up, on a short-term basis, we are wary.
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