Winter Update

In my Dec 4th Energy Alert I pointed out the straight line rally beginning in early November indicated strong buying interest and is normally seen at the beginning of major moves. I also stated straight line moves are always followed by a correction before continuing higher and set an objective to near the 200-Day MA prior to moving higher.

The following day the U.S. Energy Information Administration (EIA) released an extraordinary natural gas storage report which showed a decrease in supplies of 285 Bcf, which was the largest weekly decrease in recorded history. I discuss the ramifications of this report for natural gas and electricity rates in 2 video Energy Alerts recorded on Dec 16th & 19th, which are available on the first page of our website.These video alerts explain that based on supply concerns, any pullback will be shallow and short-lived, and as shown in the chart below, natural gas and electricity are poised to rally in the first half of 2014, much as they did in 2008.

In my Dec 19th video I point out the 2nd largest decrease in natural gas supplies occurred on 1/25/08. As you can see in the above chart the drawdown of supplies preceded an explosive rally into the summer of 2008, and I believe a similar explosive rally this year is possible.

The purpose of today’s Energy Alert is to explain the risk factors supporting a continuation of the rally in 2014. To fully appreciate this report, I encourage you to listen to my Dec 19th video Energy Alert. I will be developing several points introduced in my video alerts. The video alerts explain the high risk of the market moving significantly higher early in 2014 based fundamental and technical factors.

Fundamental Factors:

The price of a commodity is largely determined by supply/demand, which can be measured by changes in supplies. Changes in production caused by the influence of new fracking technology in 2011 and the warmest winter in 100 years in the high demand areas of the U.S. in 2011/12 resulted in the highest natural gas inventory levels in history; and subsequently natural gas prices reached a 10 year low in the spring of 2012. Over the last year we have discussed the implications of low natural gas prices from a historical and cyclical basis.

On our Historical Data page (click here), we discuss Natural Gas and Electricity prices from a cyclical and historical perspective. After reading this material you will understand present cyclical and historical price patterns support the premise that we are in the early stages of a long-term bull market and the upside risk in prices is substantial at this time.

Markets trade cyclically as suppliers restrain production when prices are low and users increase demand until prices swing to higher levels. We are experiencing this phenomenon at the present time as demand for natural gas is increasing faster than production. Today’s EIA storage report showed that Inventories of natural gas stood at 2.974 trillion cubic feet,16% below the very high levels of last year and 9% below the five-year average for the week. We are entering the winter heating season with relatively low inventory levels, which means from a fundamental perspective the risk of higher prices this winter are a very real possibility.

What is particularly troubling is the drawdown in natural gas supplies is about to accelerate due to the extremely cold weather heading into the high demand areas this weekend.

Widespread cold returns

The EIA will likely announce a weekly withdrawal of more than 250 Bcf in its January 17th inventory report due to the unusually low temperatures forecasted for early January. An already tight supply situation is about to worsen and will support higher prices.

Technical Factors:

In my October 25th Energy Alert, I pointed out large commercial hedgers were building long positions and this helped me to correctly predict the next major move would be to the upside. The chart of natural gas shows the rally in natural gas since my October 25th Energy Alert.

NG 1-3-14
In my video alerts I point out an additional risk factor supportive to higher prices at this time. Speculators continue to hold a large short position. The implication of a large short speculative position is when fundamentals change and the market moves higher the speculators scramble to cover their long positions, which adds fuel to the rally. As I point out in my video alerts we are in the process of testing the spring 2013 highs, and if we surpass the spring 2013 highs, there is a risk it will trigger a short covering rally similar to 2008.

Summary:

I believe natural gas and electricity rates are poised to move significantly higher in the first quarter of 2014 based primarily on 2 factors:

1. Low relative storage levels.
2. High level of short positions of speculators versus high level of long positions of commercial hedgers.
The very cold weather in early January will continue to drain already tight natural gas supplies, and although milder weather is forecasted for the second week in January supply levels will remain very tight. The longer-term forecasts are uncertain, but the risk you are facing is any additional Arctic blasts this winter will support an explosive rally.

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 at this time. We invite you to call one of our energy analysts to help you plan a hedging strategy appropriate for your situation.

Ray Franklin
Senior Energy Analyst