UPDATE of December 28th Energy Alert – Major Weather Revisions Trigger Sharp Correction

My reports focus on Natural Gas because it is now the largest energy source for the generation of Electricity; therefore, Natural Gas and Electricity rates are highly correlated.

In my Dec 28^th Energy Alert, I pointed out the following day the Energy Information Administration (EIA) would announce Natural Gas storage was now below the five-year moving average for the first time since the week ending 5/19/15, and given how quickly supplies declined from record levels in November with temperatures only slightly below normal the previous 30 days, storage would likely continue to decline below the 5-year moving average unless temperatures were above average this winter.

As I wrote the Dec 28^th report, Natural Gas was trading near $3.74 MMbtu, and I said if cold weather returned in January, as NOAA was predicting at that time in the forecast below, we could test $4.00 MMbtu near-term:

After writing my Dec 28^th report, the nearby NYMEX contract expired at the end of the day, and experienced a short squeeze near the close of trading, surging 25 cents from $3.74 as a wrote my report to a high of $3.99; thereby testing $4.00 prior to the release of the EIA storage report the following day. The EIA as expected did announce Natural Gas supplies were now below the 5-year moving average, which set up the following reaction.

After the report, Natural Gas prices began to pullback, which was a classic buy the rumor sell the fact phenomena. Often when an event is highly anticipated it is already discounted into the price, and the market initially sells off when the event is confirmed. But since the new nearby NYMEX contract high was only $3.90 on Dec 28^th, the initial sell off would likely have been shallow, and if cold weather returned in January, as NOAA predicted in the above chart, the new nearby contract would likely have retested $4.00 MMbtu near-term.

But as you can see below, NOAA revised their forecast for the second week in January from being colder than normal for most of the United States to average to warmer than normal for most of the United States:

And as you can see in the chart below, the dramatic change in NOAA’s forecast over New Year’s Weekend precipitated a sharp selloff, shown by the blue arrow:

But as I wrote in my Dec 28^th report, if temperatures moderated later in January, prices would pullback, and likely maintain the pattern of higher highs and higher lows, which has been in place since the March 2016 low. Therefore, I believe Natural Gas’s most recent selloff will remain above the last major selloff, shown by first the first red arrow, which was also precipitated by milder than normal weather in early November.

How deep and how long the present selloff continues is largely dependent on what weather models predict for the second half of January. If milder than normal weather persists for most of the United States, Natural Gas prices would likely decline further.

How low could prices go?

As I explained in my Nov 2nd Energy Alert, the most common long-term moving average used by technical traders to determine long-term trends is the 200-day Moving Average. As you can see in the chart above, after breaking through the 200-Day Moving Average on May 31^st, Natural Gas surged higher and other than briefly trading below the 200-day Moving Average due to mild weather for 3 days in early November as shown by the first red arrow has remained above the 200-day Moving Average.

Therefore, if mild weather presists in the second half of January, Natural Gas prices could continue to fall with the 200-day Moving Average, as shown by the second red arrow, a possible objective, but would not likely trade below this important support level. But even if milder weather persists, it is possible Natural Gas will not reach the 200-day Moving Average, but instead hold at another important moving average for technical trend followers, the 50-day Moving Average.

As you can see in the above chart, prior to breaking out above the 200-day moving average, Natural Gas traded above the 50-day Moving Average on Mar 29th, and successfully held the 50-day Moving average on 2 tests as shown by the two green arrows. Obviously moving averages do not always hold, so when do they become important? Simply stated, when they hold in spite of negative news. Therefore, I will closely monitor Natural Gas in the near-term, to see if it holds support near the 50-day Moving Average in spite of negative news, and if it appears to be holding, I will send out another update alerting you.

But if prices break below the 50-day Moving Average, we could be heading lower to test the 200-day moving average later in January.

The questions is, should hedgers secure rates now, or wait, hoping prices break below the 50-day Moving Average?

The answer is largely determined by 2 factors:

• Risk Tolerance – By definition, hedgers are risk averse; therefore, in most instances, I recommend hedgers do not attempt to catch the exact bottom on pullbacks in an upwardly trending market. As I have pointed out in previous reports, as a hedger, your objective should not be to catch the exact bottom, but to reserve rates lower than the expected average rate over the term of the hedge.
• Pricing in Forward Markets – In my Dec 28^th report, I pointed out Natural Gas’s pricing continues to experience backwardation, which occurs when nearby contracts sell at a higher price than further out contracts, and hedgers can take advantage of backwardation in Natural Gas and Electricity, by reserving the lower rates presently offered in the forward markets.

If you followed my recommendation and secured rates last week, you may feel you acted prematurely, and if you secured rates with an immediate start for only 12-months, you would have profited by waiting. But if you reserved rates with start dates further out in the forward market, as you can see in the summary of rates below, priced in $ per MMbtu, you would not have benefited by waiting:

                       Dec 28^th         Jan 4^th          Difference            

Jan 2017        $3.74             $3.28                 – 46

Apr 2017        $3.53              $3.22                 – 31

Apr 2018        $2.97              $2.90                 – 07

Apr 2019         $2.70             $2.71                 +01          

Apr 2020        $2.70             $2.71                 +01

As you can see above, rates declined sharply near-term, but further out in the forward markets rates did not decline. I am not sure how much longer the forward markets will remain in backwardation, but since over the last 20 years, the average rate was always higher the following 12, 24 & 36 months after trading near the lows we experienced in March 2016, I believe it continues to be prudent to reserve rates in the forward markets while they are in backwardation.

Tomorrow the EIA is expected to announce a -68 Bcf draw in the storage report for the week ended 12/30. A storage draw of -68 Bcf relatively speaking should be bearish. Last year the storage draw for the same period was -117 Bcf and the five-year average draw was -111 Bcf. But just as we saw last week when the market sold off after a bullish draw of -237 Bcf was announced, it would not surprise me to see the opposite reaction with Natural Gas initially declining to the 50-day Moving Average after a bearish report, and then rallying.

Not every client’s risk tolerance and hedging strategy is the same, but we trust the above report will help you put into perspective the risk/reward opportunities now. I invite you to call one of our energy analysts to help you plan a hedging strategy appropriate for your situation.

Ray Franklin
Senior Commodity Analyst
727-400-3170