Natural gas falls on weak expectations

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EMI QuickView Short Term Market Overview

Impact on Energy Prices

Price Drivers

Nat Gas

Crude

Supply

CBr

Cbr

Demand

N

N

Inventories

CBr

Cbr

Cooling/Heating Weather

CBu

N

Tropical Weather

N

N

Global Equities

CBu

CBu

Geopolitics

CBu

CBu

Technicals

N

N

Market Sentiment

N

N

Overall View

N

N

Bias

N

N

N - Neutral Bu - Bullish Br- Bearish

CBr - Cautiously Bearish CBu - Cautiously Bullish

As I projected yesterday Nat Gas prices Nat Gas prices were in the red all day after Thursday’s almost 7% surge in prices. Economic data and the latest round of corporate earnings were mostly positive on the surface but the market viewed it differently. The main economic data was the latest CPI in the US which came in as expected with inflation not an issue at the time. Three major corporate earnings reports GE, Bank of America and Citigroup all beat expectations and had a decent quarter but they all missed on revenue expectations. The market took the earnings data or in particular the revenue miss as yet another signal that the US and global economy may in fact be slowing. Equity prices were in the red throughout all of Friday’s trading casting a negative cloud over commodity prices.

In addition the Goldman Sachs rally as a result of their settlement with the SEC did not get much mileage in the markets on Friday nor did the fact that the BP oil leak in the Gulf of Mexico may finally be plugged. As another sign of economic growth slowing was the quelling of the rumor that China may ease up on its policies after Thursday’s round of economic data as the Chinese Premier said in a speech today that China will maintain policy stability in the second half of 2010 (meaning no change from current policy). He indicated the goal of the government is to balance inflation, growth and the restructuring of the economy as well as maintaining a proactive fiscal policy. The comments by the Premier suggested to the market that China ’s economy was likely to slow even further during the next six months and as such all of the major Asian equity indices declined on the news.

With China ...the global growth engine in the world... continued slowing will ultimately impact commodity consumption and this does not exclude Natural Gas especially in the form of LNG. China has been a big buyer and consumer of LNG and any slowing in their economy could result in less LNG purchased throwing up even more potential cargoes to find a home. The US has pretty much been spared the onslaught of LNG as prices in both Asia and Europe have been a lot more attractive than in the US . However, with US prices likely to firm somewhat over the next few months coupled with what is potentially looking like a slowing in demand for LNG in China (due to the economy slowing) and Europe slowing (due to the fallout from their austerity programs) could result in US values being more competitive as a destination compared to both Asia and Europe. If so any incremental LNG that begins to flow in this direction will impact prices negatively. This is not an issue we need to be overly concerned with in the short term (next month or so) but something we will have to watch in the fourth quarter and beyond.

After a few days of complete quiet on the tropical activity front market participants were served a reminder that the hurricane season is alive and well. NOAA is reporting a very low probability weather pattern evolving off of the coast of Central America . At the moment this weather pattern is expected to be very slow to evolve and currently has only a 10% or very low chance of developing into a tropical cyclone. Also late today NOAA reported another weather disturbance (also with a low probability of developing further right in the sweet spot of the oil and Nat Gas rich region of the Gulf of Mexico . For now neither weather pattern is impacting either oil or Nat Gas prices (and most likely will not) but they are serving as a reminder that the hurricane season is far from over and at some point in time over the next three months there will be a storm or two that will impact Nat Gas prices. As I have mentioned before the projected overactive hurricane season is providing a price floor and will do so for at least the next several months.

Yesterday I discussed the narrowing of the inventory overhang. Today I want to continue with that scenario by presenting a chart comparing Nat Gas price performance this year versus last year and what might be in the cards going forward. The following chart shows the seasonal performance of price for both years with the blue line representing this year’s spot Nymex Nat Gas price and the red line the price for 2009. As shown on the chart the directional performance of Nat Gas prices for this year were mostly in sync with last year’s movement throughout the majority of the heart of the winter heating season albeit this year’s price performance has been consistently running above last year’s levels (as a result of total demand starting to recover this year). By early May the relationship between this year and last started to get a bit out of sync with the 2010 price premium over 2009 widening noticeably and lasting through today.

The widening of 2010 versus 2009 prices is related to two variables. First the premium that has been built into this year’s price based on the projection of an overactive hurricane season. This part of the premium will disappear quickly if threatening hurricanes do not materialize and/or the season ends...whichever comes first. The second reason...and one which could have a more lasting impact on price...is related to yesterday’s discussion of the inventory surplus slowly starting to dissipate. The overhang has been narrowing for the last several months versus last year and for about month versus the five year average for the same week. With the potential for rig counts to fall (refer to my discussion in last Friday’s newsletter) and thus slowing supply down a bit coupled with industrial and cooling demand to continue to grow over the next several months could and most likely will result in the inventory overhang continuing to narrow for the short to medium term. As such we may not see anything like the sell-off in prices experienced in August of 2009 but we may see similar price appreciation like what we experienced in the later part of 2009.

As shown in the following chart of the current forward curve for the Nat Gas futures contract compared to where it was back in mid- April of this year one can quickly see that the contango has become noticeably less interesting. Opportunistically storing Nat Gas today is less economical than it was back in April (about the same time that the inventory overhang started to narrow). The contango (as measured by the August, 10/Jan, 11 spread) has narrowed from $1.11/mmbtu on April 15th to just $0.736/mmbtu today. Storing the same mmbtu’s of Nat Gas today is $0.374/mmbtu or 33.7% less profitable than it was just three months ago. The movement of the front end of the forward curve suggests that the market is still pricing in a hurricane and cooling premium as well as a less robust inventory injection season going forward.

Going further down the curve the market has not yet changed its view of the winter backwardation period as measured by the Jan,11/April,11 spread. The backwardation today is around $0.0305/mmbtu versus $0.331/mmbtu three months ago. Not a significant enough of a move to suggest the market has incorporated a view change. If anything I would expect the backwardation to start to get steeper if the aforementioned logic that the inventory injection season will slow down as a result of the narrowing of the contango as there will then be less Nat Gas in inventory ahead of the winter heating season.. It is much too early for one to hang their hat on a forecast of winter weather so the main premise of any change to the back end of the forward curve is based on how the front end of the curve performs going forward.

So what are the logical trades around the forward curve at this point in time. If you view the inventory overhang as improving the contango should continue to narrow thus trade the forward curve by being long the front (I would go with Sep as Aug close to moving into the history books) and short the Jan,11 contract. Carrying this scenario further if the inventory scenario materializes as discussed the Jan11,/ April, 11 backwardation should widen thus a second trade of long Jan,11/short April,11 should also work. Although I would wait a bit to enter the second trade until we see a few more data points on inventories.

Next week corporate earnings will continue to dominate the equities markets as the economic calendar is on the light side. Inventories will play a major role in setting price direction next week. I am expecting yet another narrowing of the overhang in Nat Gas inventories. The hotter than normal weather will continue to be a factor impacting cooling related consumption next week with the tropical weather activity a big unknown.

My individual market views are detailed in the table at the beginning of the newsletter. I remain in the neutral corner for today. Currently prices ended the session in negative territory but Nat Gas was still able to record a gain of about 2.5% for the week. The short put position is still in positive territory and I remain committed to this position with the options expiration right around the corner on July 27th.

Current Expected Trading Range

Expected Trading Range

7/16/10

Change

Low

High End

From

End Support

Resistance

2:35 PM

Yesterday

Aug NYM NG

$4.530

($0.056)

$4.000

$5.000

Sep NYM NG

$4.527

($0.065)

$4.000

$5.000

Aug ICE UK NG

$45.69

($1.07)

$45.00

$53.00

Aug WTI

$75.92

($0.70)

$70.00

$77.50

Dow Futures

10,078

(214)

9,800

10,500

US Dollar Index

82.645

(0.098)

80.000

85.300

Best regards,

Dominick A. Chirichella

dchirichella@mailaec.com

Energy Market Analysis is published daily by the Energy Management Institute 1324 Lexington Avenue, # 322, New York, NY 10128. Copyright 2008. Reproduction without permission is strictly prohibited. Subscriptions: $129 for annual orders. Editor in Chief: Dominick Chirichella, Publisher: Stephen Gloyd, Editor Sal Umek.

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About the Author
Dominick A. Chirichella

Energy Market Analysis is published daily by the Energy Management Institute 1324 Lexington Avenue, # 322, New York, NY 10128. Copyright 2008. Reproduction without permission is strictly prohibited. Subscriptions: $129 for annual orders. Editor in Chief: Dominick Chirichella, Publisher: Stephen Gloyd, Editor Sal Umek.

EMA has authorized Futures to publish its report once a week on Wednesday prior to the EIA release. For information on how to receive the report everyday look below.

PH: (888) 871-1207

Email info@energyinstitution.org

Subscribe here Free Trial Here

Information and opinions expressed in this publication are intended to provide general market awareness. The Energy Management Institute and the Energy Market Analysis are not responsible for any business actions, market transactions, or decisions made by its readers based on information published in this report. Readers of the Energy Market Analysis use this market information at their own risk.

This message and any attachments relate to the official business of the Energy Management Institute ("EMI") and are proprietary to EMI. This e-mail transmission may contain information that is proprietary, privileged and/or confidential and is intended exclusively for the person(s) to whom it is addressed. Any use, copying, retention or disclosure by any person other than the intended recipient or the intended recipient's designees is strictly prohibited.

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