Natural Gas: Barry-Driven Production Cuts, Hot Weather Support Upside Potential Short-Term; Downside Risk Increasing Thereafter

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

Natural gas inventory build of 81 Bcf tops consensus, making for another bearish report.

Natural gas prices finished higher on Friday after shut-ins of oil and natural gas operators lowered production and amid an impending heat wave next week.

Building heat wave to yield the hottest week of the year thus far; widespread temperatures in the 90s with heat indices in the 100s across the central and eastern U.S.

Investment Thesis

Expect for natural gas prices to continue to climb higher in the near term as a heat wave builds over the central and eastern U.S. next week. Soon thereafter, I would look for downside risk to be applied to prices assuming the cooling trend indicated by computer models verify in the 11-16 day time frame.

Natural gas prices trend higher on Friday amid Gulf Coast output cuts and an impending heat wave next week

The front-month August natural gas futures contract finished Friday up 1.72%, or 3.7 cents ($0.037), to $2.453. The September contract also settled higher 3.3 cents ($0.033) to $2.434. Figure 1 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 (UNG), which is the unleveraged 1x ETF that tracks the price of natural gas, finished up 2.08% to $21.09.

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 Friday 5.96% and 4.17% at $19.21 and $15.73, 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 5.76% and 3.79% at $130.21 and $26.62, respectively.

EIA storage report comes in bearish, topping expectations

The Energy Information Administration (EIA) released its weekly storage report on Wednesday morning. The report revealed an inventory build of 81 BCF for the week ending July 5, which fell within the trading range of 62 BCF to 84 BCF, but more than consensus estimates of 73 BCF. The build of 81 BCF for the week ending July 5 is compared to the 55 BCF build from a year ago and the five-year average build of 71 BCF. Overall, the report was bearish largely due to the Fourth of July holiday impact. Despite the bearish report with injection being above last year, consensus, and the five-year average, the bigger story surrounds Tropical Storm Barry and its impact on production and a hotter weather pattern for the upcoming week. Stockpiles stand at 2,471 BCF vs. 2,196 BCF a year ago and the five-year average of 2,613 BCF. That's 275 BCF higher than last year and 142 BCF less than the five-year average. Figures 2 and 3 below are both depictions (table and graph) of Thursday's EIA natural gas storage report for the week of July 1-5.

(Source: EIA.)

(Source: EIA.)

Tropical Storm Barry, a building heat wave, followed by potentially cooler weather late July lead weather headlines

There are three main weather stories to discuss on the weather front. The first is with regard to Tropical Storm Barry. Current forecast has Barry on track to make landfall on Saturday over the Louisiana Coast, and could do so as a Category 1 Hurricane. Friday's rise in prices was partly due to oil and gas production falling due to shut-ins pertaining to the potential impacts of Barry. According to the Bureau of Safety and Environmental Enforcement, as of Friday, nearly 49% of natural gas production, or 1.35 BCF/d, and 59% (1.11 million b/d) of oil production had been shut in. Additionally, a total of 257 offshore production platforms, or 38%, of the 669 manned platforms have evacuated. According to Tudor, Pickering, Holt & Co., Gulf of Mexico production as of Friday was down 1.3 BCF/d week/week, with Cheniere Energy Inc.'s (LNG) Sabine Pass LNG export volumes reduced to 2.9 Bcf/d, or down 0.8 BCF/d week/week. According to Genscape, production dropped to a 53-day low at 87.02 Bcf/d on Friday in response to Gulf Coast output slashing. Furthermore, Gulf Coast production dropped about 2.14 Bcf/d from the 30-year average. At about 9.3 Bcf/d of current production, volumes for the region are at their lowest levels since January 2018. Gulf of Mexico output has dropped to around 0.5 Bcf/d, a decline of 1.97 Bcf/d from the pre-storm average. South Louisiana output was also down to 0.5 Bcf/d, a loss of about 0.18 Bcf/d from pre-storm averages. Production from North Louisiana and other areas of the Gulf Coast has not been affected.

On Saturday, according to the U.S. Bureau of Safety and Environmental Enforcement, some 1.3 million bbl/day, or 70%, of oil production and 1.5 billion cf/day, or 55%, of natural gas output in the Gulf of Mexico was shut in, making the total southeast natural gas production fall to its lowest level of the year. Feedgas deliveries to Sabine Pass rebounded to 3.7 billion cf/day Saturday after falling to 2.9 billion on Thursday, and deliveries to Cameron LNG moved back above 600 million cf/day over the past two days after falling to 265 million cf/day on Thursday.

Once making landfall, Barry is expected to undergo weakening as it travels over the Lower Mississippi Valley into the southern Mid-Mississippi Valley and Lower Ohio Valley. Barry will bring pounding surf and dangerous storm surge along the central Gulf Coast, including Louisiana's coast. Additionally, Barry is expected to bring copious amounts of rainfall and potentially life-threatening flooding to south/southeastern Louisiana into Mississippi. According to the 7 am CDT advisory from the National Hurricane Center, Barry was near hurricane strength with winds of 70 mph, and was located about 50 west-southwest of Morgan City or 60 miles south of Lafayette, moving northwest at 5 mph. Should Barry reach hurricane status, it would be the first of the year. Figure 4 below is a map showing the five-day potential track area for Tropical Storm Barry.

(Source: NOAA)

The second weather story is the impending heat wave across much of the country, which promises to be the hottest period yet thus far this year. Over the next 5 days, the mercury is set to increase over the central and eastern U.S. as upper-level ridging builds with the core heat dome/591 dm sub-tropical high over the southern Rockies/central-southern Plains. Clouds/rainfall associated with Barry will keep daytime high temperatures near to, if not well below, average early next week across parts of the Lower Mississippi Valley. Expect for very warm to hot and humid conditions to prevail from the Plains to the East Coast with pockets of anomalies greater than 10 degrees from the northern Plains to the Great Lakes to the Northeast U.S. Broad upper-level ridging will result in subsidence across much of the central and eastern U.S. outside of areas in the path of Barry. Barry will also contribute to the heat across areas surrounding it (i.e., Mid-Mississippi Valley) as air vents out from the top of the remnants associated with Barry, allowing for air to sink, compress, and warm. Figure 5 below is a map from the 12z GFS ensemble depicting the 0-5 day (July 13-18) temperature pattern.

(Source: WeatherBELL)

In the 6-11 day time frame, we will see the remnants from Barry become absorbed and phase out amid upper-level ridging across the Ohio Valley. In its wake will be upper-level ridging strengthening and expanding across the central and eastern U.S., with a 594 dm heat dome centered over the Lower to Mid-Mississippi Valley. As a result, we will see temperatures trend even hotter mid-to-late next week across the central Plains, Mid-Mississippi Valley, Great Lakes region. Widespread 90s and even some 100s are likely during this time frame across these regions with heat indices running 105F to 115F+. Anomalies will range 10-15 degrees above normal. Figure 6 below is a map from the 12z ECMWF ensemble depicting the 6-11 day (July 19-24) upper-level/jet stream pattern.

(Source: WeatherBELL)

Figure 7 below is a map from the 12z ECMWF ensemble depicting the 4-9 day (July 17-22) temperature pattern.

(Source: WeatherBELL)

The third weather story involves the potential for the central and eastern U.S. to get a reprieve from the heat late July. Forecast models are indicating the heat dome shifting to the western U.S. in the 11-16 day time frame, which would allow for the heat to relax and temperature to return closer to normal levels across the central and eastern U.S. Figure 8 below is a map from the 12z GFS ensemble depicting the 11-16 day (July 24-29) upper-level/jet stream pattern.

(Source: WeatherBELL)

Final Trading Thoughts

Prices should continue to push higher in the near term amid the summer heat wave building across the central U.S. The cooler trend amongst forecast models for late July or in the 11-16 day time frame is something that will be monitored over the weekend and next week. If models remain consistent with this idea, downside risk will be applied to the natural gas strip after some near-term upward movement. My price range will be $2.25-2.55 over the next week for the front-month August futures contract, with UNG trading between $18.50 and $22.50.

Figure 9 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 9: Natural Gas Weekly Storage Injection/Withdrawal Projections over the next four weeks.

(Source: Andrei Evbuoma)

Figure 10 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 10: Observed and four-week projected natural gas inventory levels.

(Source: Andrei Evbuoma)

Finally, Figure 11 below is the current storage deficit level and my four-week projected deficit levels.

Figure 11: 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.