Natural Gas: Upside Potential Limited As Market Sentiment Shifts Bearish After Forecast Models Trend Warmer No ratings yet.

Investment Thesis

Downside risk outweighs upside potential after warmer shift in recent model runs.

Natural gas winter contracts gap lower after forecast models shifted warmer over the weekend

On Monday, the December contract settled lower 12.2 cents ($0.122) to $2.566/MMBtu. Further down the strip, the January contract settled down 12 cents ($0.120) to $2.630/MMBtu, the February contract settled down 11 cents ($0.110) to $2.585/MMBtu, and the March contract settled down 8.7 cents ($0.087) to $2.482/MMBtu.

Figure 1 below is a chart depicting the price trend of the front-month December contract over the past month.

Source: Investing.com

On Monday, the United States Natural Gas ETF (UNG), which is the unleveraged 1x ETF that tracks the price of natural gas, finished lower 4.42% to $20.10.

UNG’s leveraged exposure ETFs, the VelocityShares 3x Long Natural Gas ETN (UGAZ) and the ProShares Ultra Bloomberg Natural Gas ETF (BOIL), were seen lower by 13.2% and 8.81% at $13.74 and $12.11, 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 higher by 13.41% and 9.19% at $123.79 and $29.47, respectively.

Natural gas bears find extra support in the weather outlook as zonal flow will usher in mild Pacific air and yield near normal level temperatures in the days ahead

Over the past couple of days, forecast models have decisively shifted milder/warmer. Gone is the highly amplified (meridonal flow regime) driven by strong upper level western North American/Alaskan ridging that resulted in the recent cold pattern. In comes a less amplified (flat, zonal/semizonal regime) where the primary flow/source of air will be coming from the Pacific as opposed to the previous Arctic. That said, there’s a ton of mild Pacific air that’s set to pump into the U.S. This will influence our weather by keeping temperatures near seasonable levels with little in the way of cold air seeping into the Lower 48. Additionally, the zonal/semi-zonal regime will result in a progressive and more active/wet pattern with multiple storm systems coming into and tracking across the country from west to east over the next couple of weeks. For the most part, these storm systems will help to bring in milder/warmer air across the central and eastern U.S. with any cool air on the backside being limited.

A Rex Block pattern with ridging/higher heights to the north and troughing/lower heights to the south will develop from the eastern Pacific into the western U.S. This will set up a split jet stream pattern that from a flow standpoint will be a dominant feature over the country in the near term (over the next 5-7 days or so). Additionally, the pattern as previously mentioned will be quite progressive with numerous weather systems tracking across the country from west to east.

Over the next 5 days, the aforementioned Rex Block/split flow pattern will be in place over the eastern Pacific/western U.S. with upper level troughing developing over the eastern U.S. So the overall jet stream configuration will be zonal to semi-zonal (less amplified). As a result, temperatures look to range from near seasonable levels to warmer than normal across much of the country.

Figure 2 below is a map from the 0z ECMWF ensemble depicting the 1-6 day (November 19-24) jet stream upper level pattern.

Source: WeatherBell

In the 6-11 day time period, the Rex Block/split flow pattern will break down/fade. However, the pattern will still maintain a zonal/semi-zonal look with upper level troughing over Alaska/western Canada and upper level ridging from north-central Canada into Greenland. Additionally, the pattern remain progressive and increasingly active with at least two storm systems that’s expected to impact the central and eastern U.S. Overall, this will yield near seasonable temperatures across much of the country.

Figure 3 below is a map from the 0z ECMWF ensemble depicting the 7-12 day (November 25-30) jet stream upper level pattern.

Source: WeatherBell

The 11-15 day period features largely a continuation of the pattern from the 6-11 day time frame, though forecast models are hinting around at the idea of the pattern becoming slightly more amplified which would suggest more cool/cold air seepage into the Lower 48 and thus a slightly cooler period than the 6-11 day time frame.

Figure 4 below is a map from the 0z ECMWF ensemble depicting the 10-15 day (November 28-December 3) jet stream upper level pattern.

Source: WeatherBell

Final Trading Thoughts

The lack of upper level ridging into Alaska/Arctic Circle cuts off Arctic air flow into Canada and the Lower 48. Instead, flow comes from over the Pacific allowing for mild air to seep into the U.S. With a run of mild/seasonable temperatures in the days ahead, natural gas bears take full control of the market. Downside risk will continue to outweigh upside potential until the pattern show signs of changing/becoming more amplified.

Expect a price range between $2.45 and $2.65 over the next week for the front-month December futures contract. UNG will trade between $18.00 and $21.00.

Figure 5 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 5: Natural Gas Weekly Storage Injection/Withdrawal Projections over the next four weeks.

Source: Andrei Evbuoma

Figure 6 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 6: Observed and four-week projected natural gas inventory levels.

Source: Andrei Evbuoma

Figure 7 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 7: Observed and four-week projected natural gas inventory levels.

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.

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