Natural Gas' Path Of Least Resistance

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

Summary

Support at $2.888 going into the heart of summer.

Inventory injections point to a new record high in stocks.

Open interest moving lower suggests a rebound.

A positive set up for next winter -- buy when it looks ugly.

Natural gas should head toward $4 in 2018.

The natural gas market in the United States has evolved dramatically over past years. On the demand side of the fundamental equation, environmental initiatives have caused the use of coal in power generation to drop while natural gas-fired electric plants are flourishing. Additionally, technology has created the ability to take the energy commodity in gas form and turn it into a liquid. In the past, U.S. and North American production of the energy commodity could only travel by pipeline, limiting the potential for export to those countries bordered by land. However, in liquid form, natural gas-filled tankers can now move by ocean vessel to countries around the world where the price of the energy commodity commands a premium to U.S. prices.

On the supply side of the U.S. natural gas business, massive reserves in the Marcellus and Utica shale regions of the nation are now readily available via advances in extraction technology. Fracking has transformed the United States into an energy independent nation in the new millennium. Enormous reserves of natural gas and new demand verticals have changed the pricing structure for the commodity that has traded in a range from $1 per MMBtu to highs of over $15.60 per MMBtu since 1990. Natural gas is now trading around the $3 per MMBtu level, but technology and fewer environmental regulations under the new administration in Washington DC have brought the cost of producing a Btu down.

Support at $2.888 going into the heart of summer

At the end of May, technical support for the price of July natural gas futures stood at $3.209 per MMBtu level. Source: CQG

As the daily chart highlights, the break below support led to aggressive selling that took the price of the energy commodity down to lows of $2.916 on June 14. Natural gas had declined into oversold territory and support stood at $2.8880 per MMBtu heading into the summer season in the United States. As the price fell and headed toward those February 28 lows on the July futures contract, the price just below $2.90 stood as a line in the sand for a decline to $2.522, the continuous contract lows. Natural gas waited for the release of data from the Energy Information Administration on Thursday, June 15 before probing below $2.90 and the market expected an injection of 80-85 billion cubic feet. However, the EIA figures came in at 78 bcf, less than market expectations, which provided a reason for a corrective bounce in the price of the energy commodity which rose to the $3.06 per MMBtu level in the aftermath of Thursday's report.

Inventory injections point to a new record high in stocks

As of June 9, U.S. stocks of natural gas stood at 2.709 trillion cubic feet, 10.6% below last year's level, but still 9.2% higher than the five-year average for this time of the year. There are currently around twenty-two weeks to go in the 2017 injection season for natural gas and an average injection of 61 bcf over the period will lift inventories to a new record high above last year's record of 4.047 tcf. It now looks like we will see stocks rise to a new high in the United States sometime in November but the market ignored stocks and concentrated on the injection that was smaller than the market had expected.

At the same time, the recent decline in price came alongside a decrease in positions in natural gas futures on the New York Mercantile Exchange.

Open interest moving lower suggests a rebound

Open interest is the total number of open long and short positions in a futures market, and when it comes to natural gas, the metric recently peaked at a record level. On May 12, open interest in natural gas futures was at 1,573,595 contracts, a level that surpassed the previous record at 1,559,802 back in April 2013. Source: CQG

As of Wednesday, June 14 the metric stood at 1,446,539 which was 127,056 or over 8% below the May record level. Typically, a fall in open interest accompanied by a drop in price is not a technical validation of an emerging bearish trend in a futures market. The decline in open interest was likely the result of those holding long positions exiting the market as the price fell below technical support. The metric peaked as July natural gas futures traded to highs of just over $3.50 per MMBtu in mid-May and declined alongside the price over the past month.

A positive set up for next winter- Buy when it looks ugly

When it comes to the fundamental side of the natural gas market, there are bullish and bearish factors at play these days. On the bullish side, natural gas has become the go-to fuel for power or electricity generation in the United States. Additionally, liquefication of the energy commodity for export to other markets has added to the demand side of the fundamental equation for the energy commodity. On the other hand, massive reserves in shale regions in the U.S. and technological advances in extraction of gas from the crust of the earth have increased supplies. The Trump Administration's support for the energy industry has lowered production costs with fewer regulations for those involved in hydraulic fracking. While there is more demand for natural gas these days, there are more supplies. On the longer-term monthly chart for NYMEX natural gas, the prospects from a technical perspective are looking positive for the price of the energy commodity. Source: CQG

As the monthly pictorial illustrates, natural gas futures reached a bottom of $1.611 per MMBtu in March 2016, and since then the price has been in recovery mode. The latest high came at the end of December 2016 when the price rose to the highest level since 2014 and traded at highs of $3.9940 per MMBtu.

The summer is injection season for natural gas, and as the total quantity of natural gas in stockpiles rises over coming weeks and months, it is likely that there will be bouts of price weakness in the futures market. There is always the risk of a hurricane that could impact natural gas infrastructure along the coast of the Gulf of Mexico in Louisiana. However, absent a storm or a long period of summer heat that increases demand for electricity, the chances are inventories will continue to grow and move toward the four tcf level causing price pressure on the natural gas market. An average of 61 bcf per week until withdrawal season is not an impossible goal for this season. I believe that new demand vehicles will provide support for the price of natural gas and that we will see the price move towards, and perhaps above, the $4 per MMBtu level when the winter season arrives. Therefore, any price weakness that pushes the price down to support at $2.888 or $2.522 could create excellent buying opportunities. Right now, with oil trading at the bottom end of its trading range, there are many price pressures on the energy sector.

$4 in 2018

Natural gas peaked in 2016 at just below the $4 per MMBtu level and the last time we saw the price above there was back in 2014. I believe that we will see a return to prices above $4 per MMBtu in 2018 because of the demand side of the fundamental equation for natural gas. LNG is a new technology, but it is a profitable business for those companies like Cheniere Energy (NYSEMKT:LNG). Source: Barchart

Since February 2016, the price of LNG stock has rallied from $22.80 to $46.39 per share, an increase of over 103%. In early 2016 when LNG fell to lows the price of natural gas traded in a range from $1.682 to $2.228 per MMBtu. Today, with LNG shares at over double the value they were back in early 2016, the price of natural gas at $3.05 is up by over 36% from the highs and over 80% from the lows in February 2016. As the demand for U.S. natural gas around the world grows, the new demand vertical will likely provide support for the price of the energy commodity.

I believe that the path of least resistance for natural gas prices will turn higher next winter and any price weakness over the injection season that still has around five months to run will set up excellent buying opportunities for investors and traders. Therefore, look for periods of price weakness over coming months to dip a toe in natural gas on the long side. The fundamentals for the energy commodity are looking a lot better than they have in years despite massive supplies. There is only so much gas that can fit into storage. The price is likely to move lower as inventories pour into pipelines and storage facilities. However, demand will drain them next winter and LNG has created a market where we are likely to see a higher high than last December when the price came within less than a penny from the $4 level.

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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.