We're About To See A $2 Handle In Natural Gas

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Includes: APA, BOIL, CHK, DCNG, DGAZ, DVN, FCG, GASL, GASX, GAZ, KOLD, MLPG, UGAZ, UNG, UNL
by: Andrew Hecht

Summary

A rough week for natural gas bulls.

The energy commodity is running out of winter.

Inventory report provides little hope.

The long term picture is more positive than the short term.

Natural gas producers can offer the best value for the future on the next wash out.

I became worried about the natural gas market on Thursday, Jan. 26, when the EIA reported a withdrawal of only 119 billion cubic feet from stockpiles.

The gap on the chart from $3.536 to $3.649 on the March futures contracts has been staring many bulls in the face since the beginning of the year. Throughout the month of January, natural gas futures were unable to fill that void. March natural gas futures rose to highs of $3.828 on December 28 when the nearby contract peaked at $3.994 per MMBtu on that date. However, since the start of 2017, the energy commodity has not been able to make it above the $3.50 level on March futures since January 3. After a couple of attempts, it has spent the majority of the month trading around the $3.30 per MMBtu level which had become a pivot point.

When the price of a commodity tries to move higher and fails repeatedly, it often gives up and moves lower. What goes up tends to come down and what cannot go up tends to go down harder in the volatile world of commodities.

A rough week for natural gas bulls

Commodity prices are all volatile. However, when it comes to natural gas few commodities can compete with its penchant for price variance. On Friday, January 27 March natural gas futures closed at $3.388 per MMBtu, last Friday the price was at the $3.05 level. It was a rough week for the natural gas bulls and those technical traders still waiting for the energy commodity to fill the gaps on the daily and weekly charts.

Weather has turned colder across the Northeast and Midwestern United States with temperatures below the freezing level in New York City, Boston and Chicago over last weekend. However, the latest weather reports are calling for an unseasonal warming of temperatures in the weeks ahead spelling bad news for the price of natural gas futures. We are already trading the March futures contract and that means only one thing in the world of natural gas, we can see the light at the end of the tunnel and winter is coming to an end. Pitchers and catchers report to spring training on February 14 and farmers will soon be planting the 2017 crop.

The energy commodity is running out of winter

Last Thursday, February 02 was Groundhog Day. Punxsutawney Phil crawled out of his winter hibernation at the annual event in Gobbler's Knob and saw his shadow which means six more weeks of winter await us.

While that is good news for the natural gas market at this time of the year, the forecasts are telling us that we are in for some spring-like weather. On Groundhog Day we received the latest natural gas storage report from the Energy Information Administration. The report covered the week of January 27 and that means that there are probably only seven maybe eight weeks left of withdrawals from storage before the start of the long injection season in the U.S. The EIA report was more bullish than the market expected but it was very light for this time of the year.

Inventory report provides little hope

Market expectations for last week's withdrawal were around the 80 to 85 billion cubic feet level. So when the EIA reported a decline in inventories of 87 bcf, the price rallied from the bottom end of the trading range. Natural gas did not touch the $3.11 double-bottom support last Thursday but it did trade to lows of $3.118 before the EIA release.

Inventories stood at 2.711 trillion cubic feet as of January 27 which is 8.9% below last year's level. However, for the first time in weeks, the amount of gas in storage rose above the five year average for this time of the year and was a 2.2% above that level as of the end of January. While the report was slightly more bullish than most analysts expected, it does not provide much hope for any bulls in the market. On Friday, the price fell below the double bottom at $3.11 per MMBtu but held the $3 level, for now.

The long term picture is more positive than the short term

Now that February is upon us, the weekly chart in natural gas futures is starting to look bearish. If the average withdrawal from storage is the same as last week's number over the coming eight weeks, total stocks will only reach 2.015 tcf, hardly a number that will support a rally to fill the gaps on the charts. Source: CQG

As the weekly chart for natural gas highlights, the price action has been leaning lower since late December with a series of lower highs over the past six weeks. Open interest is steady at 1.193 million contracts but the momentum indicator indicates a downtrend. The double-bottom at $3.11 was a line in the sand for natural gas and below there the energy commodity is starting to look ugly. Sell stop orders are likely building below $3.00 and frustrated longs could head for exits if the price of the energy commodity continues to fail.

Remember, natural gas fell to the lowest price since 1998 late last February and it was during that month in 2016 that the price fell by over 65 cents per MMBtu. That fall amounted to over 25% of the price at the beginning of the month. Right now may be a great time to start planning for a price correction in the natural gas market but rather than looking to buy the commodity or the ETF or ETN products that replicate price action, the producers may offer the best opportunities in the coming weeks.

Natural gas producers can offer the best value for the future on the next wash out

Natural gas is a weather commodity and the price action over the coming weeks will be a function of temperatures and the rate of withdrawals from inventory. However, when looking towards the future the potential for price appreciation in the world of natural gas production is looking bright. The new energy-friendly administration will support the industry via fewer regulatory constraints. Less regulation will lower the total output costs for many producers. Additionally, technological advances have created a new demand vertical for the energy commodity via LNG which will result in the growth of a thriving export market in the months and years to come. With massive reserves in the Marcellus and Utica shale regions of the United States and fewer regulations on fracking, I expect producers to increase output. Profits at these producing companies will increase as natural gas travels abroad to markets where the prices are higher than domestic U.S. levels. Source: Barchart

As the chart of Apache Corporation (NYSE:APA) shows, the share price has appreciated from lows of $33.23 last February 11 to over the $59 level as of last Friday. Although the stock is up more than 78.5%, APA traded to highs of $69 in December and a pullback as natural gas prices fall below the $3 level could offer a great opportunity for the future. Source: Barchart

Devon Energy Corporation (NYSE:DVN) traded to lows of $18.07 last February and has recovered to $46.79 as of last Friday, an increase of over 158%. DVN traded to highs of $50.69 per share in December 2016. Source: Barchart

Chesapeake Energy Corporation (NYSE:CHK) fell to lows of $1.50 per share last February and has increased to $6.57, a 338% rally over the past year. CHK traded to highs of $8.20 in December.

I am keeping one eye on the price of natural gas futures and the other on the price of these companies' shares over the coming weeks. Natural gas is currently on shaky ground and it failed at the double-bottom at $3.11 which could mean that we are going to see the price below $3 very soon. Given the time of the year and the forecasts for spring-like conditions, natural gas is starting to feel very heavy and overpriced at over $3 per MMBtu. A $2 handle on natural gas is likely to send all three equity prices lower and could set up a profitable buying opportunity for the future.

I have introduced a new weekly service through Seeking Alpha Marketplace. Each Wednesday I will provide subscribers with a detailed report on the major commodity sectors covering over 30 individual commodity markets, most of which trade on U.S. futures markets. The report will give an up, down or neutral call on these markets for the coming week and will outline the technical and fundamental state of each market. At times, I will make recommendations for risk positions in the ETF and ETN markets as well as in commodity equities and related options. You can sign up for The Hecht Commodity Report on the Seeking Alpha Marketplace page.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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