Natural Gas Trades On Narrow Range As Investors Evaluate Market; Cases Can Be Made For Both The Bulls And The Bears

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Includes: BOIL, DGAZ, KOLD, UGAZ, UNG
by: Andrei Evbuoma
Summary

Market tightening some as natural gas storage levels draw near to the 1,000 bcf mark amid lingering March cold limits downside risk.

Bullish speculators fail to find a strong catalyst due to time and lack of Arctic cold next week and beyond.

Shoulder season quickly approaching as weather pattern turns stormier and progressive.

For those in the agriculture space or interested my Spring 2019 Weather Outlook, see my latest post here.

Investment Thesis

A tightening natural gas market with storage levels expected to fall towards 1,000 bcf amid lingering cool March weather supports the bulls in United States Natural Gas Fund (UNG), VelocityShares 3x Long Natural Gas ETN (UGAZ), and ProShares Ultra Bloomberg Natural Gas ETF (BOIL) on one hand. On the other hand, given that we are in March (seasonality) with no signs of Arctic air coming in after this week supports the bears in United States Natural Gas Fund (UNG), VelocityShares 3x Inverse Long Natural Gas ETN (DGAZ), and ProShares UltraShort Bloomberg Natural Gas (KOLD). Hence, natural gas investors are looking for direction as the market trades within a narrow range.

Early March Arctic cold plus lingering cool weather mid-month supports the recent upward trend of natural gas

UNG is an exchange-traded security that is designed to track in percentage terms the movements of natural gas prices. There are some exchange-traded products (ETPs) that track the movement of the underlying asset and also give investors leveraged or inverse exposure to natural gas. VelocityShares' UGAZ and ProShares' BOIL are exchange traded securities that give investors 3x and 2x leveraged exposure to natural gas, respectively. Meanwhile, VelocityShares's DGAZ, and ProShares' KOLD give investors 3x and 2x inverse exposure to natural gas.

Figure 1 below is a depiction of UNG, UGAZ, and DGAZ price movements from early February through early March. Notice how mid-February was bearish but sentiment began changing more bullish late February as investors began digesting information of a very cold start to March.

Source: Seeking Alpha

Natural gas prices have been trending upwards since mid-February. UNG prices since mid-February have climbed from $23.00 to $25.10. Natural gas contract futures March to April since mid-February have climbed 28 cents from $2.56 to $2.84. The upward trajectory of natural gas came on prospects one of the coldest air masses in history for early March to impact much of the Lower 48. Adding to that, forecast models have trended cooler over the past few days for the mid to late March period (March 15-22) which on Tuesday resulted in a 1% increase in the front-month price to $2.88 and UNG prices to $25.43, respectively.

The April contract pre-market on Wednesday contracted 4 cents to $2.84 from some profit-taking.

Figure 2 below is a depiction of the price trend of the April front-month futures contract over the past month. Notice how sentiment began to change late February on prospects of a very cold start to March.

Source: Investing.com

Figure 3 below is a depiction of the price trend of U.S. Natural Gas Fund over the past month.

Source: Investing.com

PNA aided, storm-induced cold mid-late March offers some support to the upside but lacks Arctic cold

The weather pattern across the U.S. over the next couple of weeks can be described as progressive (changeable), stormy, and largely reflective of the Pacific North American Oscillation (PNA) and the East Pacific Oscillation (EPO).

Figure 4 below is a illustration of the PNA and EPO index over the next 2 weeks.

Source: NOAA

Currently, we have well below normal temperatures encompassing much of the country with the highest anomalies over the eastern U.S. Over the next 5 days, the cold will wane and temperatures will warm/moderate over the southern U.S. and eventually the central and eastern U.S. (this weekend). In the 5-10 day period (March 11-16), the cold will be confined across the central and western U.S., amid a western U.S. trough (-PNA/negative Pacific North American signal) and downstream ridging over the eastern U.S. This will yield a cold West U.S. vs. a mild East U.S. A complete pattern shift takes place in the 11-16 day period (March 17-22) with a (+PNA/positive Pacific North American signal) resulting in ridging over the western U.S. and downstream troughing over the central and eastern U.S. This will yield a warm West U.S. vs. a cold East U.S. With all of the changes and shifts in the pattern expected over the next two weeks, the jet stream will become active and unstable resulting in a series of storm systems to impact the central and eastern U.S. This is all typical of the volatile Spring weather as cold air and warm air battle for position.

Figure 5 below is a depiction from the 06z GEFS model of the upper level pattern (500 mb) showing ridging over western North America and downstream troughing over central and eastern North America in the 11-16 day (March 17-22) timeframe. This setup reflects the +PNA nicely and will translate to the surface as a warm West U.S. vs. cold East U.S.

Source: WeatherBell

Figure 6 is a illustration from the 06z GEFS model depicting 850 mb temperature anomalies (warm West U.S. vs. cold Central/East U.S.) in the 11-16 day timeframe.

Source: WeatherBell

With regards to the cool temperatures in the 11-16 day timeframe, the intensity will not be of the Arctic variety or origin. Rather, the cool temperatures across the central and eastern U.S. will be aided by the positive PNA values and induced on the backend of the storm systems that will track across these areas. As a result, the cold will be modified resulting in lighter heating demand than what we are experiencing currently (early March). With that said, demand will likely continue to be greater than the 5-yr average in the weeks ahead as March is looking likely to average out colder than normal across the central and eastern U.S.

Figure 7 is a depiction of the temperature anomalies so far this month. Through March 5, outside of the Desert Southwest and the Southeast U.S., much of the country has experienced below normal temperatures with the core of the cold (in pink, purple, and blue) located over the central U.S. (e.g. Northern Rockies, Great Plains, Upper Midwest, Great Lakes).

Source: NOAA

Final Trading Thoughts - Bullish and bearish signals have natural gas trading within a narrow range

Given what we know about all of the bullish and bearish signals, temperatures late March into early April will ultimately determine which way natural gas goes. Additional lingering cold for late March into April will provide support for the bulls while any sign of warming across the central and eastern U.S. will add to downside risk and selling. Long-range computer models, both the ECMWF Weeklies and the CFSv2, are indicating temperatures warming across the eastern U.S. late March into early April (March 27-April 5) timeframe. Knowing this, and given that we are late in the game when it comes down to any meaningful cold air in this timeframe, risk to the downside weighs more than upside potential. I'm increasing my price target just slightly from last week at $2.88 with a range between $2.70 and $2.88. UNG should continue trading within the range of $25.00 to $20.00. There’s more downside risk at this point and bulls need to be cautious. I wouldn’t be a buyer or seeking a long short-term entry point at this stage.

Below are my withdrawal and storage projections for the next 4 weeks. Figure 8 below is my natural gas inventory withdrawal projections over the next 4 weeks vs. the 5-year average and the total 4 week projected level vs. the 5-year average.

Figure 8: Natural Gas Weekly Storage Injection/Withdrawal Projections over the next 4 weeks.

Source: Andrei Evbuoma

Figure 9 below is the observed or current NatGas inventory level and my forecast levels over the next 4 weeks vs. the 5-year average.

Figure 9: Observed and 4 week projected natural gas inventory levels.

Source: Andrei Evbuoma

Finally, figure 10 below is the current storage deficit level and my 4-week projected deficit levels.

Figure 10: Observed and 4 week projected natural gas storage deficit.

Source: Andrei Evbuoma

Stay Tuned For More Updates!

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.