Since the beginning of this year...or during the heart of the winter heating season the spot Nat Gas futures price has traded with a $3 handle during just 3 of the 34 trading days so far this year. That certainly says it all about Nat Gas this year...simply bearish off of a warmer than normal winter across most of the US. No matter how one slices and dices the fundamental data or the technical indicators Nat Gas has been and continues to be bearish. The results of the tremendous success in shale gas drilling continues to result in supply outstripping demand resulting in inventory withdrawals over just about the entire winter heating season underperforming versus both last year and the more normal five year average.
We are now at the time of the year that whether weekly withdrawals either over or underperform it is not going to make a huge difference insofar as the total amount of Nat Gas in inventory at the end of the season coming in at an all time record high level. The upcoming shoulder season (beginning in about a month or so) is setting up to be a bearish period for Nat Gas unless production declines start to ramp up versus currently announced levels. The injection season is likely to come in full force and just as withdrawals underperformed all season we may see injections over performing the historical period as supply remains robust and the economics of storing Nat Gas are continuing to improve each week as the forward curve contango widens.
Certainly the big variable for Nat Gas prices during the medium term will be very dependent on the summer weather, nuclear plant maintenance shutdowns, hydro power availability and the upcoming hurricane season. Any one or a combination of events can certainly act as upside price drivers for Nat Gas during the May to September period. Beyond that Nat Gas prices will be very dependent on how the injection season has been progressing insofar as how close total inventories are to available capacity. Also if the summer season turns out to be a neutral for Nat Gas the moment of truth will be coming for many producers insofar as seriously looking at cutting production if prices are very depressed in early fall as many of the producers have limited hedges on for 2013.
As detailed in this week's EIA Weekly Nat Gas report Nat Gas power burn is up in spite of a warmer than normal winter. December retail sales of electricity showed the second greatest year-over-year decrease for the month since the U.S. Energy Information Administration ( EIA ) started collecting data in 1973, due in part to a relatively warm winter this season. Despite this 6.1 percent drop in retail sales, natural gas consumed for power generation in December increased 8.2 percent over December 2010 levels. More recent BENTEK Energy LLC (Bentek) estimates show that natural gas consumed in the power sector this February was almost 27 percent greater than the natural gas power burn in February 2011, and 17 percent greater in January 2012 than in the same month in the previous year. In contrast, EIA's estimates of coal consumed for power generation for December of 2011 were 17.4 percent lower than the previous December.
While much of the increase in natural gas-fired generation has been seen in the Southeast United States, Ohio has also experienced large increases over the last several years, as highlighted in EIA's recently released Electric Monthly Update. Traditionally, natural gas-fired power plants in Ohio have been used for peaking purposes (run for a few hours on certain summer days when demand for electricity is high). Recently, these plants are being dispatched more throughout the year and not just a few hours of the day in the summer, at the expense of less efficient coal plants.
This week the EIA will release the weekly Nat Gas inventory report on its regularly scheduled day and time...Thursday, March 8th. This week I am projecting a net withdrawal of 81 BCF which is modestly above last year but below the more normal five year average for the same week. My projection for this week is shown in the following table and is based on a week that experienced some seasonable winter weather over some areas of the country. My withdrawal forecast is based on the fact that heating related demand was around normal last week in some parts of the country. My projection will be greater than last year's net withdrawal level of 63 BCF but below the normal five year average net withdrawal for the same week of 92 BCF. Bottom line the inventory surplus will widen this week versus the five year average but narrow a bit versus last year 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 738 BCF. The surplus versus the five year average for the same week will widen to around 792 BCF. This will be a neutral weekly fundamental snapshot if the actual data is in line with my projection. The industry is projecting a net withdrawal of 70 to about 95 with the consensus still forming.
It is difficult to determine how the market will react to this week's inventory report. It is likely to be very dependent on how the market trades during the first half of the week. If prices continue to trend lower and work their way toward the lower end of the trading range than a withdrawal that comes in larger than last year could be a catalyst for a short covering rally. On the other hand if the market trades up during the first half of the week as market participants view the weekly projections than a withdrawal that outperforms last year as currently projected could turn out to be a buy the projections sell the fact type of a trading pattern. We will watch the trading pattern closely to get a better feel as to the potential market reaction.
Last week crude oil declined the most since the current uptrend began to gain momentum back in December of last year. There were several mixed signals last week impacting the perception of the two main oil price drivers...geopolitics and liquidity via quantitative easing. There were also several major takeaways from the way the market traded last week. The first takeaway clearly shows that market participants are very nervous over the evolving geopolitical situation in the Mid-East as demonstrated by the very quick upside reaction to a unconfirmed report of a pipeline explosion in Saudi Arabia (later denied by Saudi officials). The market is very jumpy and extremely sensitive to anything that might indicate that a supply interruption is occurring or about to occur in the middle East especially if Iran and/or Saudi Arabia appears to be involved.
The second takeaway also involving the Middle East was demonstrated when the market interpreted comments by President Obama on Friday that a preemptive strike on Iran may not result as the rest of the Gulf region may sympathize with Iran. The market viewed that comments as one that suggest the US would not engage in any preemptive military strike. This comment and interpretation resulted in the market selling off on Friday. The takeaway being any peaceful resolution to the current crisis like Iran coming to the negotiating table will result in a strong decline in oil price...like back to below $100/bbl basis WTI.
But don't forget that it is not the US that is likely to be involved in a preemptive strike rather it is more likely to be Israel. On Sunday President Obama spoke to the American-Israel Public Affairs Committee. On Monday he will be meeting with President Netanyahu with Iran likely to be the only topic of the meeting. Obama seemed to lay the groundwork on Sunday for Monday's meeting with Netanyahu by indicating that no option is off the table but "there is too much lose talk of war". He wants to pursue a diplomatic and sanctions route to resolution. I would say Obama's Sunday's comments are biased to the bearish side for oil. That said we will have to see how the meeting turns out on Monday and how the market then interprets the outcome of that meeting.
The Iranian elections took place on Friday with loyalists to the Supreme leader Khamenei winning about 75% of the seats at the expense of Armadinejad loyalists. I do not think the outcome will change Iran's foreign policy nor does it seem to be resulting in any widespread demonstrations as we saw a few years ago after the Presidential elections. For what it is worth Armadinejad may now be a lame duck President for the rest of his term. But again it is not likely to change Iran's stance on nuclear enrichment. The main event for oil prices in the very short term will be the outcome of Monday's meeting between Israel and the US.
The third takeaway from last week's trading bring us to the second price driver...liquidity from Central Banks. Earlier in the week US Fed Chairman Bernanke was testifying before Congress and his failure to discuss a potential QE3 was viewed by the market as a sign that QE3 was off the table. This resulted in a quick sell-off led by the most visible inflation instruments precious metals followed by declines in oil and equities. On Thursday the ISM manufacture data hit the media airwaves coming in well below the expectations as well as the previous month strongly suggesting that the economy in the US may be slowing.
Normally this outcome is bearish for oil as well as the equity markets. However, it turned out to be bad news is good news in that the market interpreted the data point as one that suggests that QE3 is likely back on the table...if it was ever off or on the table in the first place. The takeaway demonstrates the participants are very sensitive to ongoing slugs of liquidity or at least the perception of another liquidity slug to the market.
Lastly on the demand side of the equation all eyes are solidly fixed on China. The macroeconomic data out of China has been a bit disappointing over the last few weeks and today the government lowered their GDP target from 8% to 7.5% for 2012 with an inflation target of about 4%. Since China is the largest oil demand growth engine in the world any lowering of expected economic growth...as occurred today is a bearish signal for oil suggesting that oil demand growth is not going to be as high as the latest round of forecasts. The market has reacted to this change by China as oil prices are lower across the board. The mild sell-off in oil prices are also a result of what I view as a conciliatory speech by President Obama yesterday and one that does not seem to include military action by the US any time soon.
The one thing that did not change last week is the fact that the two main oil price drivers remain solidly in play...geopolitics and liquidity. Oil remains in an uptrend supported by the aforementioned price drivers irrespective of the fact that oil prices declined on the week and into the morning so far. The three scenarios I detailed last week on the geopolitical front are still very much the three main scenarios. We are possibly at the cusp of entering scenario 2 which is a ramping up of the potential for an Israeli strike on Iran...this week may provide a better idea after the meeting with Obama and Netanyahu. Unless there is a sudden move toward a more peaceful resolution I expect the current uptrend to remain in place. In the short term I also view the geopolitical price driver a more dominant oil price driver than the potential for more market liquidity or a change in China's GDP projections.
I am still keeping my view at neutral and bias at bearish for another day or so to see if the rally over the last two days continues into next week. The surplus is still building in inventory versus both last year and the five year average is going to get harder and harder to work off even it gets cold over a major portion of the US and as such for the medium to longer term I am still very skeptical as to whether NG will be able to muster a sustained upside rally over and above a short covering rally.
WTI is still trading above its most recent resistance level of $104/bbl (now a support level with $110/bbl the next level of resistance. Brent has also breached its resistance level of $120/bbl yesterday. But as with WTI... Brent is also settling into a new short term trading range of around $119/bbl to $126/bbl. Oil continues to be driven by the evolving geopolitics of the Mideast...in particular Iran with just about all of the other normal prices drivers taking a secondary role...including fundamentals. I am keeping my view at cautiously bullish and keeping the caution flag flying to remind all that the market is still susceptible to further profit taking selling as we have seen so far this week.
Currently markets are lower as shown in the following table.
Dominick A. Chirichella
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