Seeking Alpha

Natural Gas: Volatility Increases After A Strong Rally

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

EIA's inventory build of 89 BCF comes in line with traders' range, but slightly more than consensus, making it another bearish report.

Southern Alaska sizzles in a significant heat wave courtesy of a prominent North Pacific Rex Block; multiple all-time high temperatures broken.

Natural gas futures soar nearly 20 cents over the past two trading sessions as a warm to hot and humid air mass engulfs much of the country over the next two weeks.

Investment Thesis

Given that the past couple of trading sessions have rallied strongly in response to a hotter weather outlook over the next couple of weeks, investors need to be careful getting too aggressive given that we still have to figure out how hot it's going to get and whether or not the major natural gas consumption regions get in on some bona fide heat. So far so good, but look for upside potential to be limited until some key details get ironed out.

EIA reported another bearish storage report on Wednesday with an inventory build of 89 BCF; could be last bearish report for a while

The Energy Information Administration (EIA) released its weekly storage report on Wednesday morning. The report revealed an inventory build of 89 BCF for the week ending June 28, which fell within the trading range of 76 BCF to 103 BCF, but fell slightly more than consensus estimates of 85 BCF. The build of 89 BCF for the week ending June 28 is compared to the 76 BCF build from a year ago and the five-year avg. build of 70 BCF. Despite the bearish report with injection being above last year, consensus, and the five-year average, the bigger story on Wednesday was the shift to a hotter weather pattern in the 8-15 day time period. Stockpiles stand at 2,390 BCF vs. 2,141 BCF a year ago and the five-year avg. of 2,542 BCF. That's 249 BCF higher than last year and 152 BCF less than the five-year avg. Figures 1 and 2 below are both depictions (table and graph) of Thursday's EIA natural gas storage report for the week of June 24-28.

Source: EIA

Source: EIA

Natural gas futures jumped over 6% or nearly 20 cents over the past couple of trading sessions amid a hotter weather outlook

On Wednesday, the front-month August natural gas futures contract settled higher nearly 2%, or 5 cents ($0.050), to $2.290. The September contract also settled higher 4.6 cents ($0.046) to $2.263.

On Wednesday, the United States Natural Gas ETF (UNG), which is the unleveraged 1x ETF that tracks the price of natural gas, finished up 1.82% to $19.61.

UNG's leveraged exposure ETFs, the VelocityShares 3x Long Natural Gas ETN (UGAZ) and the ProShares Ultra Bloomberg Natural Gas ETF (BOIL), were seen higher Wednesday 5.87% and 3.45% at $15.68 and $13.50, respectively. Meanwhile, UNG's high-beta leveraged inverse ETFs, the VelocityShares 3x Inverse Natural Gas ETN (DGAZ) and the ProShares UltraShort Bloomberg Natural Gas ETF (KOLD), were seen lower 5.32% and 3.38% at $166.03 and $31.46, respectively.

The front-month August natural gas futures contract finished Friday up 4.85%, or 12.8 cents ($0.128), to $2.418. The September contract also settled higher 12.6 cents ($0.126) to $2.389. Figure 3 below is a chart depicting the price trend of the front-month August contract over the past 24 hours.

Source: Investing.com

On Friday, the United States Natural Gas ETF, which is the unleveraged 1x ETF that tracks the price of natural gas, finished up 5.62% to $20.68.

UNG's leveraged exposure ETFs, the VelocityShares 3x Long Natural Gas ETN and the ProShares Ultra Bloomberg Natural Gas ETF, were seen higher Friday 16.26% and 11.04% at $18.23 and $14.99, respectively. Meanwhile, UNG's high-beta leveraged inverse ETFs, the VelocityShares 3x Inverse Natural Gas ETN and the ProShares UltraShort Bloomberg Natural Gas ETF, were seen lower 17% and 11% at $137.75 and $27.98, respectively.

Southern Alaska broils in historic 90 degree heat; forecast models trend hotter as much of the Lower 48 is expected to remain in a warm to hot pattern over the next couple of weeks

The large scale weather pattern is set where a warm to hot pattern is dominating a huge swath of real estate across North America. Included in this is a pronounced Rex Block over the North Pacific/Southern Alaska that's producing a significant heat wave across southern Alaska. Anomalously strong upper level ridging associated with the Rex Block covers much of the state with a 588 dm heat dome centered over southern Alaska. This heat dome is what's fostering dry weather, record-breaking heat, and air quality issues across southern Alaska. All-time high temperatures have been recorded throughout Southern Alaska with high temperatures reaching the upper 80s. Anchorage Alaska broke its all-time high temperature after topping out at 90F degrees on the 4th of July. Figure 4 below is a map from the 12z ECMWF ensemble depicting the current upper-level/jet stream pattern.

Source: WeatherBell

Further downstream, an upper level trough will dig/strengthen over the western U.S. producing cooler-than-average temperatures and some unsettled weather over the next five days.

Meanwhile, broad upper level ridging over the central and eastern U.S. with a heat dome cover the southern 2/3rds of the country will produce above-average temperatures over the next five days. Overall, the Desert Southwest will see temperatures climb into the 100s while much of the Lower 48 and Southern Alaska will see temperatures in the 80s and 90s.

Mid week to late week next week or in the beginning parts of the 6-11 day, upper level troughing associated with a surface cold front will track across the U.S. from west to east bringing in cooler weather, albeit brief/transient. This will bring temperatures closer to normal across the northern tier states during this time frame. Meanwhile, upper level ridging over the southern U.S. will shift its focus towards the southern Rockies/Four Corners region during this same time frame (mid-late week next week). In the 9-11 day time frame, this upper level ridge over the Southwest U.S. will have a greater influence over much of the Lower 48. While the aforementioned upper trough fizzles out by the time it reaches the East Coast, the upper ridge over the Southwest U.S. will expand northeastward helping to bring a warm to hot pattern across much of the country in the 9-11 day period. This is the hotter adjustment that the forecast models have made over the past couple of days. Figure 5 below is a map from the 18z GFS ensemble depicting the 6-11 day (July 11-16) temperature pattern.

Source: WeatherBell

Forecast models have also supported a warm to hot pattern across much of the country continuing in the 11-16 day time frame. Figure 6 below is a map from the 12z ECMWF ensemble depicting the 10-15 day (July 15-20) temperature pattern.

Source: WeatherBell

Overall, the central, southern, and eastern U.S. will see a mostly warm to hot pattern over the next couple of weeks with the western U.S. warming up next week. From a precipitation standpoint, much of the country will be around average over the next couple of weeks. Maybe a bit wet over parts of the Plains and the southeast U.S., and dry over the south-central U.S.

Final Trading Thoughts

With there being no real signs of this warm to hot pattern abating anytime soon given the recent hotter trends amongst the forecast models, expect more bullish inventory reports to come over at least the next 2-3 weeks. Given the strong move up on Friday, the market has responded to the hotter trends and much of that trend could already be priced in now. It remains to be seen how hot it gets nationally, and whether the major natural gas consumption regions get in on the real heat. That said, upside potential shall be limited in the near term. My price range will be $2.20-2.50 over the next week for the front-month August futures contract, with UNG trading between $18.00 and $22.00.

Figure 7 below is my natural gas inventory withdrawal projections over the next four weeks vs. the five-year average and the total four-week projected level vs. the five-year average.

Figure 7: Natural Gas Weekly Storage Injection/Withdrawal Projections over the next four weeks.

Source: Andrei Evbuoma

Figure 8 below is the observed or current natural gas inventory level and my forecast levels over the next four weeks vs. the five-year average.

Figure 8: Observed and four-week projected natural gas inventory levels.

Source: Andrei Evbuoma

Finally, Figure 9 below is the current storage deficit level and my four-week projected deficit levels.

Figure 9: Observed and four-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.