Natural Gas - Above $2.90 Or Below $2.75? That Is The Question

About: VelocityShares 3x Long Natural Gas ETN (UGAZ), Includes: BOIL, DGAZ, FCG, GASL, GASX, GAZB, KOLD, MLPG, UNG, UNL
by: Andrew Hecht

A wild time from November through January.

A one-month tepid rally runs out of gas.

Inventories support a test at $3.

Is the injection season a magnet for the downside?

A growing market on the supply and the demand side; UGAZ and DGAZ will magnify smaller market moves.

Taking some literary license from William Shakespeare in Hamlet, "To be or not to be (a bull or bear) that is the question" for natural gas as we head towards the 2019 injection season. "Whether 'tis nobler (or profitable) to suffer the slings and arrows of outrageous fortune" by being long or short "Or to take arms against a sea of troubles" by sitting on the sidelines.

Natural gas futures have been trading in a range between just over $2.75 per MMBtu and just under $2.90 per MMBtu on the April futures contract since late February. Each time the price approaches the highs, it looks like it will make a beeline for $3, and when it traded to the lowest end of the range, it looked as if another test of support at just above the $2.50 level is in the cards for the energy commodity.

I have been trading the Velocity Shares 3X Long Natural Gas ETN product (UGAZ) and its bearish cohort (DGAZ) over the recent days and weeks. I have been buying dips and selling rallies which worked well, so far. However, natural gas is a cruel teacher at times, and each time I pull the trigger on the long or the short side of the market, I risk losing all of my recent gains. As the injection season approaches in only a few short weeks, inventories are at the lowest level in years, but production remains at record levels. Natural gas is lulling me into a false sense of security, and I would not be surprised if the price decides to break out of its trading range and hand out another dose of intense financial pain to those sitting comfortably on the wrong side of the market as they trade the range.

A wild time from November through January

As the 2018/2019 withdrawal season began to appear on the horizon in September and October, the lowest level of natural gas in storage in years caused the price to work its way higher. By the end of September, the price of nearby futures climbed above the $3 per MMBtu level. In October 2018, the price made it up just under $3.37. In November, the price blasted off to the highest level since 2014.

Source: CQG

As the weekly chart highlights, natural gas futures exploded through technical resistance levels at the 2018 peak at $3.661, and the 2016 high at $3.994 per MMBtu like a hot knife goes through butter in mid-November before the official start of the winter season. A cold spell took nearby natural gas futures up to $4.929 per MMBtu, the highest price since 2014 when natural gas rose to $6.493 per MMBtu.

The rally at the very start of the peak season for demand could not make it to the $5 level, and in December the price collapsed below $4. In January, the price probed below the $3 level before recovering to $3.722 when it turned lower and wound up at a low at $2.543 per MMBtu in mid-February. Ironically, natural gas remained at a price that was just marginally higher than the 2018 low at $2.53 which was just a bit above the 2017 bottom at $2.522 per MMBtu.

The weekly chart shows that after all the price action, natural gas futures remain in oversold territory when it comes to price momentum. Relative strength reveals a neutral condition. Open interest at 1.20575 million contracts as of March 13 has plunged from almost 1.7 million in early October as the price prepared to explode to the upside. The wild price action chased longs and shorts from the market and sent the metric to the lowest level since early 2017 recently. The wild time in November through February that took the price to $4.929 then back to $2.543 gave way to a far more sedate market over recent weeks that has been working its way higher.

A one-month tepid rally runs out of gas

After trading to a low at $2.565 per MMBtu on February 7 on the April futures contract, the price of natural gas has slowly recovered.

Source: CQG

As the daily chart of the nearby futures contract illustrates, the price climbed from the February 7 low to a high at $2.896 per MMBtu on March 6. On Thursday, March 14, following the latest inventory numbers, the price was at the $2.845 per MMBtu level, just under the recent peak.

Natural gas has been trading in a narrow trading range of a bit under 15 cents since February 28 with support at $2.75 and resistance at $2.90 per MMBtu on the NYMEX April futures contract.

Inventories support a test at $3

On Thursday, March 14, the Energy Information Administration reminded the natural gas market that the peak season for demand has not come to an end in March 2019, just yet. The EIA reported that natural gas inventories declined by 204 billion cubic feet for the week ending on March 8, 2019.

Source: EIA

As the chart shows, the total amount of natural gas in stockpiles around the United States stood at 1.186 trillion cubic feet as of March 8 which is the lowest level in years at this time of the year. The last time that stocks dropped below the one trillion level at the end of the withdrawal season was in March 2014 when they found a bottom at 824 billion cubic feet. In February 2014, the price of the energy commodity rose to just under $6.50 per MMBtu.

The latest data shows that inventories are 23.2% below last year's level at this time of the year and 32.4% below the five-year average. Mother Nature will determine when the temperatures climb to levels where withdrawals will shift to injections over the coming weeks, but we are now very near that time of the year.

Is the injection season a magnet for the downside?

The winter months are the peak time of the year for natural gas demand. The most significant price appreciation over recent years occurred from November through February. The coming of the injection season is likely causing a rising number of market participants to become bearish, looking for the price of the energy commodity to drop as record levels of output from the Marcellus and Utica shale regions begin to replace the natural gas consumption during the recent months. However, over the past three years, the price of the energy commodity reached its low for the year during February and March. In 2016, nearby natural gas futures fell to a low at $1.611 per MMBtu, the lowest price since the late 1990s. In 2017 the bottom was at $2.522, and last year it was at $2.53 per MMBtu. Time will tell if the February 2019 low at $2.543 will stand as a bottom for this year.

With natural gas trading at 30 cents above its February low on March 14, there is certainly room for a correction to the downside over the coming weeks as the market moves into the injection season. However, with inventories at their lowest level since 2014, and technical resistance at $2.90 closer than support at $2.75, a surprise rally that takes natural gas for a test of the $3 per MMBtu level is not out of the question over the coming days and weeks. For now, I will continue to trade the range in this confusing energy commodity selling as the price approaches $2.90 and buying below $2.80 per MMBtu. However, I will quickly stop out of risk positions if the price action violates the trading band that has been in place throughout March.

A growing market on the supply and the demand side; UGAZ and DGAZ will magnify smaller market moves

There is no doubt that natural gas will flow back into storage over the coming weeks and months as producers tap into the quadrillions of cubic feet of reserves in the Marcellus and Utica shale regions. However, as natural gas continues to dominate coal in power generations in the US and the LNG export business grows, two expanding demand verticals offset at least some of the pressure caused by massive reserves and record levels of output.

The narrow trading range in the natural gas market continues to make the Velocity Shares 3X Long Natural Gas ETN product and its bearish counterpart attractive tools for approaching the energy commodity when it comes to trading the current price band. The fund summary for UGAZ states:

The investment seeks to replicate, net of expenses, three times the performance of the S&P GSCI Natural Gas Index ER. The index comprises futures contracts on a single commodity and is calculated according to the methodology of the S&P GSCI Index.

The summary for DGAZ is the inverse of the UGAZ triple-leveraged product. The gearing of UGAZ and DGAZ make them only appropriate for short-term forays into the natural gas market as both ETN products suffer from time decay and periodic reverse splits which destroy their value. However, during volatile periods in the natural gas market on the up and the downside, these tools can provide incredible returns over short horizons.

With the injection season right around the corner and inventories at the lowest level since 2014, there are not likely "outrageous fortunes" available on the up or the downside in the natural gas futures market over the coming days and weeks. Trading the current range using leveraged tools seems to be the optimal approach to natural gas these days. While the time of the year tells me the price should test the bottom end of the range soon, the price action and stock level are pointing to a test of $3 per MMBtu. Additionally, the price pattern over the past three years currently favors the upside.

I favor the upside in the market, but I am not getting carried away and will continue to focus on grinding out small profits and avoiding significant losses in the natural gas market over the coming weeks.

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.

Additional disclosure: The author always has positions in commodities markets in futures, options, ETF/ETN products, and commodity equities. These long and short positions tend to change on an intraday basis.