Natural Gas - Ugly Price Levels For The Bulls Could Be An Opportunity

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About: Direxion Daily Natural Gas Related Bull 3x Shares ETF (GASL), Includes: BOIL, DGAZ, FCG, GASX, GAZB, KOLD, MLPG, UGAZ, UNG, UNL
by: Andrew Hecht
Summary

The lowest price since 2016 - rising open interest could be a sign that shorts are pressing.

Injections are weighing on the price of the energy commodity.

Could we reach four tcf by the start of next winter?

Will trade disputes curb demand for U.S. LNG exports?

GASL continues to drop.

The natural gas market had a hideous week. The price of the nearby July futures contract fell to the lowest price since 2016 as it slipped below the $2.40 per MMBtu level. On June 5, the energy commodity fell to a low at $2.3550 per MMBtu. The bears are licking their chops with visions of the 2016 low at $1.611 per MMBtu dancing in their heads.

As production continues to grow and natural gas flows into storage across the United States at an accelerated pace, the price is disintegrating. Those who bought natural gas at fresh three-year lows are either exiting positions or nursing growing losses. Natural gas had rallied in May as the July contract reached a peak at $2.731 on May 20. The continuous futures contract rose to $2.70 per MMBtu. The price of natural gas is falling in an environment where all energy commodities are experiencing losses. Crude oil declined by over 20% at the recent low in what many analysts now call an official "bear market." The price of coal has dropped on the back of the two leading energy commodities. Only ethanol has moved higher, but that is on the back of strength in the corn futures market.

I have been on the sidelines in the natural gas market over the past week, cheering the price lower. I am hoping that I can pick up some extraordinarily cheap call options for the winter months in December 2019, and January and February 2020. The price of the Direxion Daily Natural Gas Related Bull 3X Shares product (GASL) that holds shares of many of the leading natural gas producing companies has dropped to a level where a reverse split is on the horizon. I say, let the energy commodity fall, because the lower it goes, the greater the opportunity for later this year.

The lowest price since 2016 - rising open interest could be a sign that shorts are pressing

The price of natural gas fell to a lower low on May 31 as the price moved below the $2.50 per MMBtu level.

Source: CQG

As the daily chart of July NYMEX natural gas futures highlights, the price continued lower, reaching its most recent nadir at $2.3050 on June 6, the lowest level since June 2016. Price momentum and relative strength indicators have moved into oversold territory on the daily, weekly, monthly, and quarterly charts. The decline has been steady, causing daily historical volatility to remain around the 26% level, a far cry from the levels seen last November through January. Open interest, the total number of open long and short positions in the natural gas futures market increased from 1.264 million to 1.326 million contracts since May 28, before the price ventured below the $2.40 level. The rise in the metric likely reflects the increased selling from trend-following shorts looking for the price to fall to even lower levels over the coming weeks.

Injections are weighing on the price of the energy commodity

Last week, the market was expecting a substantial injection into inventories of around 115 billion cubic feet. The Energy Information Administration did not disappoint when they reported that 119 bcf flowed into storage around the US.

Source: EIA

The chart shows that the increase in inventories rose to 1.986 trillion cubic feet, 10.1% above last year's level, but still 10.8% below the five-year average for this time of the year. Inventory data over the past has weighed on the price as triple-digit injections over the past four weeks have caused stockpiles to rise to almost two trillion cubic feet.

Could we reach four tcf by the start of next winter?

As the market begins to look forward to the 2019/2020 withdrawal season which starts in November, there are approximately 23 weeks left in the injection season, if last year is a guide. Last year, stocks peaked at 3.79 tcf before withdrawals took them to 1.107 tcf in March. To reach the 3.79 tcf level at the end of the injection season, stocks need to climb by 78.5 bcf on average each week. To reach four trillion, an average build of 87.6 bcf would take it to that level. The current price pressure could be on the back of the rising potential for more supplies in storage at the start of the next winter season of peak demand.

Will trade disputes curb demand for U.S. LNG exports?

Discoveries of massive reserves of natural gas in the Marcellus and Utica shale regions of the US and rising production caused the price of the energy commodity to drop to the lowest price since the late 1990s in 2016. However, the replacement of coal with natural gas in power generation in the US, and technological advances which created the opportunity to process natural gas into liquid form for export around the world on ocean vessels combined to increase the demand side of the fundamental equation.

The trade dispute between the US and China and protectionist policies now threatens to spread to Mexico starting on June 10. On May 31, President Trump announced that his administration plans to slap a 5% tariff to the US neighbor to the south, which will rise by 5% each month. While the US-China dispute is an attempt by the US to level the playing field for international trade, the issue with Mexico centered around the Mexican governments lack of cooperation when it comes to immigration and the flow of drugs across the border. Later this year, the wave of protectionist policies could spread to Europe where issues surrounding tariffs on automobile

Many suppliers of LNG claim that they are sold out of the commodity for the next decade, but protectionism could stand in front of expansion plans for the business.

GASL continues to drop

The lower price of natural gas and falling crude oil prices have been bad news for the share prices of natural gas producers. However, the silver lining could be the current selloff in the market. If the shorts succeed in pushing prices towards the $2 per MMBtu level or lowers, it could set up an attractive buying opportunity for the next season of peak demand.

Source: RMB/NYMEX

As the chart illustrates, natural gas is trading at below the $2.80 per MMBtu level from December 2019 through February 2020, the peak time for demand during the withdrawal season. If the price continues to drop, I will be looking to buy call options at strike prices at $2.50 to $3.00 per MMBtu for the winter months.

The decline in the share prices of producers has caused the Direxion Daily Natural Gas Related Bull 3X Shares product to fall to a level where a reverse split is on the horizon. Leveraged ETN products like GASL decay quickly when the price of the underlying asset remains stable and even more rapidly when they fall as the price for leverage is time decay. The fund summary for GASL states:

The investment seeks daily investment results, before fees and expenses, of 300% of the daily performance of the ISE-Revere Natural Gas Index. The fund, under normal circumstances, invests at least 80% of its net assets (plus borrowing for investment purposes) in financial instruments, such as swap agreements, and securities of the index, exchange-traded funds ('ETFs') that track the index and other financial instruments that provide daily leveraged exposure to the index or ETFs that track the index. The index is designed to take advantage of both event-driven news and long-term trends in the natural gas industry. The fund is non-diversified.

The most recent top holdings of GASL include:

Source: Yahoo Finance

The price of GASL was at around the $4.15 per share level last Friday.

Source: Barchart

As the chart shows, GASL declined from $8.68 per share in late April as the price more than halved in value. I will be putting GASL on my radar over the coming weeks. If the price of natural gas continues to slide, it could offer a way to turbocharge long positions in natural gas producing companies when buying the dip in the energy commodity.

Natural gas futures were trading at the $2.337 level last Friday. The break to the lowest price since 2016 could be setting up a golden opportunity for later this year as seasonality tends to take the price of the energy commodity higher as the peak season of demand approaches.

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.