Natural Gas: Slight Pullback Is Possible, But Overall Sentiment Is Still In Favor Of The Bulls

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

Natural gas futures finish flat after prices fell nearly 2% after weekly injection report topped analyst expectations; October futures contract finishes down just 1 cent.

EIA reported a bearish miss on Thursday with an inventory build of 84 BCF for the week ending August 30; trade consensus was 78 BCF, 5-year average was 66 BCF.

Week-over-week supply increases while demand drops per EIA.

Heat shifts south as near to record-breaking temperatures are expected along the Gulf Coast through mid next week; overall weather pattern turns warmer in the 6-16 day time frame.

Investment Thesis

Natural gas prices could see a short pullback after Thursday's supply/demand report, but should continue to move higher thereafter, as upside pressure still outweighs downside risk.

Natural gas rally shows resiliency; futures recover losses after a bearish inventory miss to finish Thursday's trading session flat

On Thursday, the front-month October natural gas futures contract settled lower down 0.37%, or 1 cent ($0.010), to $2.435, the November contract lower 0.1 cents ($0.001) to $2.491, and the December contract up 1 cent ($0.010) to $2.641. Figure 1 below is a chart depicting the price trend of the front-month September contract over the past month.

(Source: Investing.com)

On Thursday, the United States Natural Gas ETF (UNG), which is the unleveraged 1x ETF that tracks the price of natural gas, finished up 0.09% to $21.13.

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 on Thursday by 0% and 4.40% at $0.75 and $14.81, 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 by 0.19% and 0.46% at $117.88 and $26.18, respectively.

Major short-squeezing has natural gas bears on the run; prompt-month October contract rises more than 18% over the past month

This week so far, the October contract has climbed 16 cents, including 7.3 cents on Tuesday and 8.7 cents on Wednesday. Last week, the October front-month contact netted a 13-cent increase. Over the past month, since bottoming out at $2.07 cents, the October natural gas contract has increased as much as 18.4% to $2.45.

Natural gas' run-up of prices (including this week's rally) can be attributed to a continuation of what's been a major short squeeze (short-covering) courtesy of seasonal considerations (now trading the October contract and looking ahead to the upcoming winter season), near to record-level liquified natural gas (LNG) exports, limited demand impacts from Hurricane Dorian, and the prospects of warmer-/hotter-than-normal weather through mid-September.

EIA inventory reports a bearish miss for week ending August 30; weekly injection tops analyst expectations

The Energy Information Administration (EIA) released its weekly natural gas storage report on Thursday morning. The report revealed an inventory build of 84 BCF for the week ending August 30. This fell on the higher end of the trading range of 67-90 BCF, and was higher than consensus estimates of 78 BCF. The build of 84 BCF for the week ending August 30 is compared to the 64 BCF build from a year ago and the five-year average build of 66 BCF. Stockpiles stand at 2,941 BCF vs. 2,558 BCF a year ago and the five-year average of 3,023 BCF. That's 383 BCF higher than last year but 82 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 August 26-30.

(Source: EIA.)

(Source: EIA.)

EIA: Supply increases week/week, while demand dips week/week

The EIA also released its weekly supply/demand data on Thursday afternoon. The data showed that week/week output increased 0.5 BCF/d, from 96.2 BCF/d to 96.7 BCF/d, for the week ending September 4. That puts the year/year at a surplus of 6.4 BCF/d (96.7 BCF/d vs. 90.3 BCF/d). Meanwhile, total demand fell 0.9 BCF/d, from 85.4 BCF/d to 84.5 BCF/d, for the week ending September 4, with the year/year up 3.8 BCF/d (84.5 BCF/d vs. 80.7 BCF/d). Overall, the report was in favor of production with the week/week increase compared to demand, which slipped week/week.

The increase on the production side was by and large due to increased Canadian imports, as dry natural gas production remained constant week/week.

The week/week decrease in demand came largely from a decrease in U.S. natural gas demand and not from LNG exports.

Figure 4 below is a table breakdown of Thursday's EIA natural gas supply report for the week ending September 4.

(Source: EIA.)

Figure 5 below is a table breakdown of Thursday's EIA natural gas demand report for the week ending September 4.

(Source: EIA.)

Figure 6 below is a graph showing the natural gas supply/demand balance over the past year.

(Source: EIA.)

CME Group launches physical LNG export futures contract; available for trading October 14 (pending regulatory review)

On Wednesday, the Chicago Mercantile Exchange (CME) group announced that they will be launching a U.S. LNG Export futures contract where LNG buyers/traders will be able to purchase/trade physical volumes of the fuel. According to the firm, Cheniere Energy's (LNG) Sabine Pass LNG facility in Louisiana will be the first facility where participants would take deliveries from, with Freeport's (FCX) LNG terminal on the upper Texas coast and others to be included in later delivery months. According to CME's global head of energy Peter Keavey, the launching of LNG futures contracts (coupled with the Henry Hub Natural Gas Futures) will help the energy industry in being more effective and efficient in managing price risk around the world, particularly at a time where the U.S. is poised to become a significant player of freely traded LNG cargoes. The U.S. is expected to become the world's largest exporter of LNG by 2024 (surpassing Australia and Qatar), per the International Energy Agency (IEA). After growing 4.6% in 2018, the fastest annual pace of growth since 2010, global natural gas demand is already coming off a record year.

Hurricane Dorian weakening as it moves northward, but still impacting areas along the southeastern U.S. and Mid-Atlantic coasts

Hurricane Dorian is a category 2 storm with max sustained winds of 100 mph. As of the latest update, Dorian was located about 35 miles southeast of Wilmington, NC, and was moving north-northeast at 13 mph. A northeastward movement is expected to continue with an increase in forward speed through Saturday. On the forecast track, the center of Dorian will move near or over the coast of North Carolina tonight and Friday. The center should move to the southeast of extreme southeastern New England Friday night and Saturday morning, and should approach Nova Scotia later Saturday or Saturday night. Dorian is expected to undergo further weakening over the next few days. It is, however, expected to remain a powerful hurricane as the center moves near the coasts of South and North Carolina. Dorian is forecast to become a hurricane force post-tropical cyclone by Saturday night as it approaches Nova Scotia. Figure 7 below is a map depicting the projected path of Hurricane Dorian.

(Source: NOAA/NHC)

The heat is on the move amid a weather pattern change; western U.S. to turn cooler as heat shifts from the western states to the south-central, southeastern, and east-central U.S.

Over the next 5 days (or through early next week), the nation will undergo a weather pattern change. This change will include the western U.S. turning cooler, while the southern and east-central U.S. turns much warmer/hotter. Currently, broad area of mid-upper level ridging with the core heat dome over the south-central U.S. is resulting in much-above-normal temperatures extending from the western half of the country into the southern U.S. Over the next day or by Friday, this heat will quickly shift from the western U.S. to the southern U.S. This heat across the southern U.S. (south-central and southeast) will persist through at least early next week. Additionally, this warmth/heat will expand northward into the mid-Mississippi, Tennessee, and Ohio valleys early next week as upper-level troughing out West begins to ramp up, helping to amplify the large-scale pattern a bit. By the time we get to early next week, the pattern shift would be complete with upper-level troughing over the western U.S. and downstream upper ridging over the central and eastern U.S., with the heat dome centered over the Southeast U.S.

Despite the warm-up coming early next week over the Upper Midwest and Great Lakes regions, temperatures over the balance of next 5 days will average cooler than normal due to more influence of upper-level troughing over Canada and frequent southward advancing cold frontal boundaries. The northeastern U.S. will also have temperatures run cooler than average over the next 5 days.

Starting Friday, the southern U.S. (south-central into the Southeast U.S.) will see daytime high temperatures range from the mid-90s to the lower 100s. Near to record-breaking temperatures will be possible along the Gulf Coast from Texas eastward to Florida. These hot temperatures will continue through at least early to mid next week. Figure 8 below is a map from the 12z ECMWF ensemble depicting the 1-6 day (September 6-11) temperature pattern.

(Source: WeatherBELL)

In the 6-11 day time period, upper-level troughing over the western U.S. will begin to retrograde and fade westward, before reestablishing itself over the Gulf of Alaska. As this happens, the overall upper-level pattern will flatten and become less amplified (more zonal or east-west), allowing for mild/warm Pacific air to advect into the Lower 48. Warm to hot temperatures will continue across the southern and east-central U.S. Temperatures will warm across the northeastern U.S. and will also moderate across the western U.S. Overall, the pattern during this time frame will average normal to warmer/hotter than normal across the country. Figure 9 below is a map from the 12z ECMWF ensemble depicting the 7-12 day (September 12-17) temperature pattern.

(Source: WeatherBELL)

In the 11-16 day time period (or through mid-September), the pattern remains zonal, with temperatures averaging normal to warmer/hotter than normal across the country. Figure 9 below is a map from the 12z ECMWF ensemble depicting the 10-15 day (September 15-20) temperature pattern.

(Source: WeatherBELL)

Overall, warmer to hotter-than-normal temperatures will encompass much of the country over the next couple of weeks, with a pattern change taking place in the short term before becoming more stable in the medium range (6-16 day, or through mid-September).

Final Trading Thoughts

The market reacted to Thursday's bearish injection miss by the front-month October contract falling nearly 2% shortly after the report, just to rebound to finish the trading day with prices holding steady. Natural gas bulls' ability to absorb the blow just goes to show how sentiment has changed over the past month.

The week-over-week uptick in production and decrease in demand does not help the bulls' case, but sentiment has changed, as there's been a myriad of variables that have supported prices to the upside. That the bearish inventory report didn't move the needle, and the fact that in the coming weeks injection is not expected to be that far removed from average, suggest that injection in the coming weeks may not play a vital role in dictating where prices go.

That said, I expect the possibility of a very brief pullback in prices after the tear the market has been on and after the supply/demand data. However, upside potential still outweighs downside risk. Because of that, after a possible brief pullback, prices should move higher.

Expect a price range between $2.35 and 2.60 over the next week for the front-month October futures contract. UNG will trade between $19.50 and $24.00.

Figure 10 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 10: Natural Gas Weekly Storage Injection/Withdrawal Projections over the next four weeks.

(Source: Andrei Evbuoma)

Figure 11 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 11: Observed and four-week projected natural gas inventory levels.

(Source: Andrei Evbuoma)

Finally, Figure 12 below is the current storage deficit level and my four-week projected deficit levels.

Figure 12: 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.