Nat Gas is settling into the $2.25 to $2.50/mmbtu trading range that I have been suggesting all of last week. There is enough coal to gas switching resulting in an increase in the call of Nat Gas for power generation to keep the weekly injections underperforming and thus putting a floor on prices. However, even though the surplus in inventory has been narrowing it is still large enough to keep the industry on alert that maximum storage capacity could be hit prematurely and thus acting as a cap on prices. Total storage is currently at 68.6% full with the Producing region now at 80.6% of the maximum available capacity. There are still about 25 to 26 weeks left to the injection season suggesting that either demand has to increase further from current levels and/or production will need to decline much more significantly than it has so far or else storage will hit capacity and production will be forced back into the ground. I still expect the producing sector to cut further rather than allow infrastructure limitations to dictate how they operate.
This week the EIA will release the weekly Nat Gas inventory report on its regularly scheduled day and time...Thursday, June 7th. This week I am projecting the eleventh net injection into inventory of 50 BCF. My projection for this week is shown in the following table and is based on a week that experienced some cooling. My injection forecast is based on the fact that only minimal cooling related demand occurred last week. My projection compares to last year's net injection level of 99 BCF and the normal five year average net injection for the same week of 81 BCF. Bottom line the inventory surplus will narrow again this week versus last year and the five year average if the actual data is in sync with my projections
If the actual EIA data is in line with my projections the year over year surplus will narrow to around 701 BCF. The surplus versus the five year average for the same week will narrow to around 675 BCF. This will be a bullish weekly fundamental snapshot if the actual data is in line with my projection. The industry projections and consensus are still forming.
A slightly bullish data point hit Friday when the latest Baker Hughes rig count showed a decrease of 6 rigs deployed to the Nat Gas sector. With this week's decrease the total Nat Gas rig count is still hovering at the lowest level in about 13 years as the ratio of the spot WTI price to the spot Nat Gas actually receded off of its record high from a few weeks ago. Rigs deployed to the Nat Gas sector remain well below the threshold (around 800) that many analyst would expect to see production starting to decline.
Rigs deployed to the oil sector increased this week by 3 to 1383. Horizontal rigs decreased by 8 to 1183 but still remain near record high levels. The following chart kind of says it all when you plot Nat Gas rigs versus oil rigs and place the spot WTI/Nat Gas futures market price ratio on the chart. As long as the price trend continues E&P players are going to continue to be biased to oil drilling. The oil to Nat Gas price ratio narrowed last week to 35.8 from 36 the previous week moistly driven by the downside correction we have seen in Nat Gas prices over the last several days. At this level rigs are still likely to continue to be moved out of the Nat Gas sector and placed in the oil sector.
The decline in Nat Gas rigs still seems like it has room to decline... as recently as the fourth quarter of 2009 less than 700 rigs were deployed to the Nat Gas sector. If the producing economics of Nat Gas continue to decline or even stay at current levels as we approach 2013 we could see an acceleration in the decline of Nat Gas drilling as it appears that many producers are not sufficiently hedged for 2013 and beyond. On the other hand if oil prices continue at current price levels more and more rigs are going to be deployed to this sector. Even with more rigs being deployed to the oil sector it will result in more Nat Gas production as about 60% of all Nat Gas produced comes from associated wells.
Although Nat Gas is mostly US centric any major collapse from an EU event is likely to also impact Nat Gas prices. In viewing all of the other major equity and commodity markets it looks like nothing really matters other than the next macro event. Yes the technicals for oil and most risk asset markets are suggesting lower prices and yes the fundamentals for oil are bearish but all of that is secondary as the markets are moving in unison on each event that hits the media airwaves concerning the sovereign debt issues in Europe...in particular Spain and Greece as well as any indication that the global economy is slowing further. In fact the markets are relative simple at this point in time. Prices are likely to continue to move lower with short covering rallies from time to time (the market is very oversold right now and susceptible to a short covering rally). However, even if the EU pulls something out of their magic hat in the short term the trading and investing world still has to deal with the simple fact that the global economy is continuing to slow with major regions of the world very close to moving back into a recession.
From a technical perspective WTI looks like it is heading for a test of the $80/bbl level with a decent probability of trading with a $7 handle before forming a strong and sustainable bottom. Brent looks like it is heading to a test of the $90/bbl level. From a pure seasonal pricing relationship it does not look like a significant short covering rally will occur before the third week or so in June. Coincidently that happens to be the time of the next US Fed meeting as well as the full EU leaders meeting. So how do we trade, invest and hedge in such a volatile and somewhat unpredictable environment that is laden with tremendous unknown event risk?
As far as trading is concerned we trade the very short timeframe trade...which for the moment is downward for oil and most all other traditional commodities and equity markets and we employ tight trailing stops. From an investing perspective we hold the majority of our money in cash or bonds until a clearer picture emerges. There is no system that will allow the investing side of the equation (or position trading side) to pick a bottom. A bottom will form at some point but it could be at a significantly lower level than where most markets are currently trading. That said once a bottom is formed and it is clear that it has formed there will be ample time to move our very safe hoard of cash back into the risk asset markets and participate in what is likely to be a very substantial rally.
If you are a buyer of commodities you should be minimizing the size of your hedging portfolio and confine yourself to using options related strategies for hedging. If you are a seller of commodities your hedging portfolio should be at the highest level that is allowed by your risk management policies. Also a substantial amount of your hedges should also be options driven since this is an event driven downturn at the moment and an event or two is likely to serve as a catalyst to possibly turn the market direction around 9at least for a short correction).
If I would to try to categorize what is bullish and bearish as you will see from my list below it is biased to the bearish side.
- Geopolitics. At any time the talks between Iran and the West can break down and the risk of military action by Israel and/or the West could then result in a major supply disruption in the Middle East. That said I do not think that will be the likely outcome. I believe that the sanctions and the overproducing by Saudi Arabia, Kuwait and the UAE are going to keep oil prices lower forcing Iran to agree to some deal.
Stimulus or quantitative easing. The US, China and Europe are all likely to continue to add more liquidity to the market. I do not think any of these programs will fix the structural problems that exist in the global economy today but I do expect the market to react bullishly ...at least for a period of time...to more announced QE programs.
It is an election year in the US. If it starts to look like there is a good chance that Obama will lose the election we could see a relief rally emerging from the US as change generally always brings a rally in risk asset markets.
- We may be approaching a Lehman moment in Europe. If Greece is either forced out of the euro or chooses to leave on its own accord contagion will occur and it could lead to a huge problem with Spain. The unintended consequences of a Greek exit are huge and are likely to be biased to more selling of risk asset markets. I also do not think the EU is quick enough to handle what could be a very fast moving set of events.
Even if the EU does keep it all together the fact that economic growth is slowing in every corner of the world strongly suggests that the world is heading toward a period of low commodity and equity prices. I do not think the recession or growth slowing will be as severe as what we saw at the peak of the great recession but it will be strong enough to prevent a recovery in global employment and thus economic growth for a substantial period of time.
Oil in particular is going to be biased to the bearish side from a fundamental viewpoint as I do not see the Saudi's lowering production anytime soon as I believe they view their ability to handle a lower price for a significant period of time as a very strong weapon in helping the West in preventing Iran from moving closer to a nuclear bomb.
China is an unknown risk. I am not certain China is going to be able to easily spend its way out of the current slowdown as there are still lots of bubbles (housing in particular) in China as well as a tremendous amount of overcapacity like entire cities with no population. China does not seem ready to throw huge sums of money in trying to jump start their economy. The latest talk of a so called mini stimulus program may work somewhat for China but is will not work so strongly that China will be the savior of the global economy as it was during the heart of the great recession.
There are more bearish drivers but I think I have captured the major ones for now. Needles to say I remain bearish for oil and most risk asset markets until the signs are clear that the world has structurally changed. I am not investing in anything for the longer term at this point in time and have the majority of my portfolio in cash. I continue to trade oil and other risk assets from a very short term time horizon always with tight stops. I do not see that view changing for the foreseeable future (meaning most of June).
I am keeping my view at neutral and keeping my bias at neutral with an eye toward the upside now that Nat Gas has moved back to much more representative levels that are in sync with current fundamentals. The surplus is still narrowing in inventory versus both last year and the five year average but could lead to a premature filling of storage during the current injection season. However, I now believe that we may see other producers starting to signal a cut in production. We may still see lower prices (thus the basis for my bias) but I think the sellers are losing momentum.
I am keeping my view at cautiously bearish after oil broke down on all fronts once again both WTI and Brent are trading at levels not seen since the fall of 2011. Oil is still solidly below the trading range it was in just a few weeks ago and well below several key support areas yet again. WTI is still solidly trading in double digits with Brent now below the $100/bbl mark. The trend remains downward but oversold.
Currently markets are mixed as shown in the following table.
Dominick A. Chirichella
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