Lies, Bad Lies And Natural Gas Statistics: Trading Principles For Bulls And Bears

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Includes: BOIL, CHK, COG, DGAZ, FCG, GASL, LNG, UGAZ, UNG, USO
by: Steve Frechette
Summary

The natural gas market is ultra short term in focus, but long term fundamentals dominate the trading range.

Lack of resistance on the recent slide is a bad omen for short and medium term Bulls.

What to be watching now if you're long or short an active position.

The extreme volatility of the past two months has bulls searching for answers. I've observed many hopeful comments the past month from under-water bulls focusing on future demand initiatives including LNG export projects and increased exports to Mexico. The reality is this: natural gas is a short term market, but the trading range is defined by the longer term supply and demand fundamentals. Three months from now is an eternity when it comes to L48 dry gas production or the drilling rig count. Just think about where dry gas production was at the end of August versus today. Understanding these short and long term forces is critical if you want to be a successful natural gas trader. Weather and short term factors control where we are in the trading range, but the range is defined by longer term fundamentals including the supply forces we examined in my last article. I strongly believe we're locked in a $2.40 to $3.20 price range until the E&P's take decisive action on future production.

Stronger international LNG pricing vs. last year is great for Cheniere's (NYSEMKT:LNG) Sabine Pass and Dominion's (NYSE:D) new Cove Point facility which is undergoing commissioning activities over the next ~90 days. After Cove Point, the next needle-moving LNG projects are Cameron, Freeport and Corpus Christi which are not expected to start activity until early 2019. The analyst community believes there's a strong probability these large projects will be delayed based on management guidance in the Q3 conference call discussions. As a result, LNG exports are capped for the next year at ~3.3 bcfd for Sabine Pass and ~0.75 for Cove Point. ~4.1 bcfd is nothing to sneeze at, but that's the max capacity for an effective eternity in the natural gas world.

Mexports have not scaled as fast as many bulls hoped mainly due to infrastructure delays south of the border. Mexico will be a great demand growth story for the next decade, but recent trends have slowed due to the lengthy nature of infrastructure projects. Mexican daily exports are in the neighborhood of ~4.5 bcfd and not expected to eclipse ~5 until the big projects come online in 2019.

Here's an example of the short/medium term factors I review every morning to gauge if we're above or below fair value in the current trading range.

Morning Data Points:

  1. Weather is the two-thousand pound gorilla of the natural gas universe. The NOAA CFSv2 weather forecasts trended bearish overnight for the week 3 and 4 maps demonstrating a typical La Nina pattern with cooler temps hugging the US/Canadian border and above average temps for the southern ~60% of the US. The shorter term NOAA 6-10 & 8-14 day forecast maps continue to oscillate between slight bullish and slight bearish netting out to "average" withdrawals. **FYI the 6-10 & 8-14 maps are a blended ensemble of 40% GFS, 40% Euro and 20% Canadian weather models. I had no idea this was the case until I researched this on the NOAA website last week. Traders normally focus their attention on changes in the Euro and GFS ensemble weather models, but the GFS has performed poorly the past year losing confidence in the trader community. The GFS has effectively lost it's ability to move the market. There are many pay-for weather forecasting services ranging from the very expensive such as the Commodities Weather Group (CWG) to more affordable, consumer focused sites such as WeatherBell. There's a popular saying in the natural gas community: "Every senior natural gas trader is just a junior meteorologist". My suggestion is not to overdo it with the weather analysis since it's an incredibly hard task where the best experts are frequently dead wrong. It's more important to understand what the market thinks about the latest weather expectations, and then watch how the market reacts to new data.
  2. What is the current trend? The recent slide down has been fast and brutal with little resistance despite weather forecasts that are closer to five year averages than table-pounding bearish. Traders are watching the lack of resistance closely and it's causing buyer hesitation as everyone waits for someone else to be the first hero through the door. The futures are getting a nasty habit of starting out 1-2% higher pre-market and giving up the gains when the bell rings. Not a bullish omen for short or medium term investors.
  3. What are key opinion leaders thinking? The popular natural gas website CelsiusEnergy.net uses the volatile GFS model for it's EIA report projections. Traders are ignoring this model more and more as we mentioned earlier in this article so consider your data source carefully. CelsiusEnergy has attracted a big audience and is mandatory daily reading to stay on top of Force Majeure's estimates and trading commentary. It's a great website and great resource even if I don't always agree with the author's views.
  4. LNG Export Demand: Sabine Pass is at ~3.1 bcf as of 12/14, down a touch from the demonstrated max of ~3.3, but still a strong print and much needed by the bull camp. I like to imagine what the price curve would be without Sabine Pass consuming a huge percent of the daily S/D surplus. No notable activity from Cove point yet as the commissioning ramp continues to disappoint the bulls.

Using trading rules to mitigate risk

Whether you're a bull or bear, you need to have strict stop-loss rules in place for every trade based on your risk tolerance, and YOU HAVE TO STICK TO YOUR RULES NO MATTER WHAT! There's no room for ego in the fast moving natural gas market. You may think natural gas is a superb bargain or massively overpriced, but fighting the tape is a one-way ticket to the poor house when it comes to the widow maker. In the past 22 months, natural gas has traded as low as $1.60 and as high as $4. Never say never when it comes to natural gas! You can always buy back when the fundamentals and technicals change in your favor. It rarely pays to be the first hero through the door unless you're Chuck Norris and bulletproof. I don't know any successful traders who make it a habit to average down. The smartest and richest traders I know cut their losses quickly and add to winning positions. If you've lost 10% on your trade, something is wrong with your thesis, not the natural gas market.

If you're short right now, congratulations for sticking it out. Many on the bear side cashed in a little too early, myself included, expecting an opportunity to re-short at higher levels. I'd strongly consider taking 25-35% position profits here, but would let the remainder ride until there's a big volume up day closing near the highs of the day signaling a potential trend change. Set your investment objectives at night when the market is closed and your mind is clear. Natural gas is a great magician capable of making huge gains disappear quickly. Sentiment is extremely bearish now, but as I pointed out in my last article, the weakness is warranted if you believe future production indicators are pointing to higher supply for 2018. It's time to be greedy if you're already short and have a cushion of protection, but keep a close eye on production and weather expectations.

I received a private message asking if I would short gas here via UNG or a purchase of DGAZ. The prospect scares me after the big drop, but often the scariest trade is the winning trade for natural gas. I'm still on the sidelines, but my spider sense is tingling each hour that passes without any serious buyer volume showing up. I can't advise putting on a new short here for beginning investors, but aggressive traders should be considering this option especially if it's a day trade. If you take the plunge, make sure you can stay glued to your terminal.

Conclusion

My official position is to be patient on the sidelines waiting to see what the big players do after the weekly EIA report. I keep asking myself why is ~$2.50 such a crazy thought and what else needs to happen for gas to breakdown further?

The E&P management teams have all the power to start the next rally. Cut L48 production immediately, cut gas rigs 30-50%, and harvest the large DUC inventory until the market stabilizes at a higher level.

Nothing can be done about strong associated gas production due to higher WTI pricing. The same goes for the big midstream projects scheduled for the next 180 days which have strong political support in Washington.

Conversely the E&P's are making an equally important statement if they do nothing to mitigate the bearish future production indicators.

Thank you for reading and good luck with your trades!

Disclosure: I am/we are long LNG. 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.

Additional disclosure: I trade UGAZ & DGAZ aggressively and can enter a new trade at any time.