The surprise rise in Nat Gas prices since the end of August continued on expiration day for the October future contract as a strong short covering rally dominated the majority for the trading session on Wednesday. The October Nat Gas contract ended its trading tenure above $3/mmbtu while the newly anointed spot November contract (due to the strong contango on the market) started its tenure as the spot contract at around $3.25/mmbtu after adding another $0.036/mmbtu in overnight trading (so far).
As I have discussed on several occasions this week the normal weather related fundamentals do not support the current price level. In addition at $3.25/mmbtu Nat Gas coal to gas switching is clearly back to being favorable to coal and as such it seems to be just a matter of time before some utilities beginning the switch back to coal to reduce their exposure to any possible winter related surge in Nat Gas prices if the winter is colder than last year.
Further raising the caution flag as to how long Nat Gas prices can continue to hold at current elevated price levels is the 90 day forecast issued by NOAA and several private forecasters over the last few days. The medium term forecast which covers the first half of the winter heating season is projecting cooler than normal temperatures across the western third of the nation with the rest of the US (the higher demand heating area of the US) likely to experience above normal temperatures through the end of the year. As with the shorter term temperature forecast the medium term projections are also not very supportive for higher Nat Gas prices as demand does not look like it is going to surge during the first half of the winter heating season.
Normally when a new contract month moves into the spot position the market normally adjusts for the wide price gap ...as is the case from the expiring October contract to the new November contract. The contango was very wide and November is trading about $0.25/mmbtu above where October was trading prior to expiration. Normally in a market that is biased to the bearish side the higher valued new contract month would be very susceptible to a modest downward sell-off. On the other hand in a market that is biased to the upside prices would hold.
The Nat Gas market does not have a lot of fundamental support to keep prices at the current level. Certainly there is still coal to Nat Gas switching demand as well as Nat Gas demand to compensate for the above normal level of nuclear plant outages but both of these fundamentals drivers are likely to decline going forward. With the weather forecast neutral at best for the rest of the year I would expect the market to be very susceptible to a modest to even strong round of profit taking selling. Today's weekly injection report could turn out to be a catalyst if the actual injection level comes in above the market expectations. At the moment the consensus injection level is 76 to 78 BCF depending on what survey one looks at. Anything in the 80s could be enough to send the weak longs back to the sidelines.
This week the EIA will release the weekly Nat Gas inventory report on its normal schedule... Thursday September 27 at 10:30 AM. This week I am projecting a 80 BCF net injection into inventory. My projection for this week is shown in the following table and is based on a week that experienced minimal (if any) Nat Gas cooling or heating related demand and no loss of GOM supply from Isaac as production was operating normally for the timeframe covered by this week's inventory report. My injection forecast is based on the fact that a lower percentage of the US experienced any temperature related Nat Gas demand. My projection compares to last year's net injection of 104 BCF and the normal five year net injection for the same week of 76 BCF. Bottom line the inventory surplus will narrow modestly this week versus last year but widen a tad versus the five year average as injections continue to rebound now that we are in the lower demand shoulder season. This week's injection will be at 77% of last year and 110% of the five year average for the same week if the actual outcome is in sync with my forecast. For interest the average for the injection season to date has been around 71% of last year.
If the actual EIA data is in line with my projections the year over year surplus will narrow to around 295 BCF. The surplus versus the five year average for the same week will widen to around 282 BCF. This will be a neutral to slightly bearish weekly fundamental snapshot if the actual data is in line with my projection. The very early industry projections are coming in a range calling for an injection of 70 to 85 BCF with the consensus forming around 76 to 78 BCF.
Crude oil continued its push lower on Wednesday as the spot WTI contract moved modestly below the lower end of the short term trading range as market participants discounted the surprise draw in crude oil (see below for a more detailed discussion on this week's inventory report) as being a result of a larger than normal decline in imports which is likely to return to more normal levels in the next week or so. In addition to the negativity that emerged after the EIA inventory report the oil and broader risk asset markets were already under pressure as protests were underway in both Spain and Greece over the populace's objections to the austerity programs. The actions in Europe yesterday were a reminder to the market that all is just not yet well in Europe and the evolving sovereign debt issues that have been plaguing the EU for well over three years are still fueling the cloud of uncertainty.
In overnight trading that has been a small rebound in oil prices as well as in the broader risk asset markets as a light round of short covering has emerged pushing the spot WTI contract back over the $90/bbl level. At the moment the negative tailwinds have been overtaking the more bullish headwinds for most of the trading week so far. The slowing of the global economy combined with an ample supply of crude oil in the near term along with global oil consumption slowing is more than offsetting the potential for an inflation fueled outcome from the new and expanded round of quantitative easing in the US, UK and Japan coupled with the bond buying program announced by the ECB. The reality of the state of the state of the global economy is currently offsetting the perception view of what more stimulus might do to the economy. At the moment the market sentiment is becoming more biased to the downside ... at least for crude oil.
On the refined products front the underperformance of both gasoline and distillate fuel inventories versus last year and the five year average has resulted in the deficit in inventory continuing to widen for both of these oil products. The plethora of refinery issues of late... including the issue at Irving's St. John refinery on Wednesday has contributed to the strong short covering rally in RBOB gasoline yesterday. Refined product inventories are at the lowest level in quite some time. However, the fact that oil consumption in the US is continuing to decline is offsetting some of the bullishness coming from the supply side of the equation. That said in the oil complex crude oil will underperform the most in down legs while refined products...in particular RBOB gasoline will outperform in up legs in the short term.
I am keeping my view at neutral with a bias to the upside as the industry is back to normal operations after Isaac but the market is trading based on a perception of what the upcoming winter may do to Nat Gas related demand. At current prices the economics now favor coal over Nat Gas and there are no major weather pulls on demand.
Oil has become more reasonably valued after about a 10% downside correction (basis WTI). WTI is still currently in a $90 to $100/bbl trading range while Brent is in a $110 to $120 trading range. Both crude oils are now trading at the lower end of the trading range and if solidly breached to the downside we could see an expansion of the range over the next few days. With the bearish current fundamentals and the slowing of the global economy driving price the bias is to downside in the near term for crude oil but to a lesser extend for refined products based on the profit taking selling that started late last week.
Markets are mostly higher as shown in the following table.
Dominick A. Chirichella
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