Natural Gas: Where Art Thou Reflation?

We’ve phrased the title for this note in olde English, much as our competitor Dennis Gartman might use.  No, don’t worry, we aren’t going to give Dennis a hard time today.  He’s already had a tough time lately (we hear down -2.2% in July in his retirement and personal accounts) and, to be honest, we find him a likeable sort, despite his dependency on one factor models such as the 200-day moving average.  For those that have missed the commodity reflation theme in the year-to-date, the question above remains an interesting one.  That is, is natural gas the next commodity to make a big move?

The pricing for natural gas is much more locally based then its global brethren, such as oil and copper.  Therefore, a weak US dollar and an increase in Chinese demand will not necessarily sway the price of natural gas in the United States.  These are the primary factors as to why natural gas has been a laggard in the year-to-date.  In fact, prices at the Henry Hub are down 40% year-to-date from $5.63 per MMBtu at the start of the year and 70% from the year-ago closing price from $11.15 per MMBtu.  The natural derivative of this decline in gas prices, is the decline in drilling.  According to Baker Hughes, gas rotary rig count is down 47% from the start of the year to 672 currently and at their lowest level since May 10th, 2002, which obviously should lead to supply declines in the future.

The major bearish factor continues to be supply.  Natural gas in storage is 25.6% above inventories of 2,297 BCF from one year ago, and 18.7% above inventories for the 5-year average.  In fact, according to the Energy Information Administration, “natural gas in storage is now at its highest level for any week in the month of July since collection of weekly storage began in 1994.”  This is obviously bearish, but is also a backward looking indicator.  As always, what will drive natural gas futures will be the next marginal change, even if only bullish on the margin.

The next marginal bullish shift will likely be a sustainable decline in the rate of the building of storage, which will be a function of weather being warmer than expected, which lead to demand for more cooling, or an eventual declining in production due to declining drilling rates.  While the rate of storage growth y-o-y has wavered from week-to-week, in aggregate we have seen a consistent build throughout the year.  Of course November 1st will be the key date to watch on storage levels, as it marks the end of the 7-month injection season.

According to Keith the quantitative set up is as follows (see chart):

“TAIL, broken = $5.45. TREND and TRADE = the same level, $3.82 (ie right where it closed on Friday. The setup is for a big move next (failure to breakout or a big time breakout)… if we see the breakdown, there is zero support until $3.11; breakout resistance is the TAIL line.”

On a percentage basis, this commodity has the potential for pin action and while the fundamentals favor an overly loose market at this point, a bullish shift in fundamentals could lead the potential for a test of the TAIL line at $5.45, which is 42% upside.

Daryl G. Jones

Managing Director

Natural Gas:  Where Art Thou Reflation? - gas


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