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Schork Oil Outlook: All Gassed Up

Status quo: Underground caverns, mines and aquifers are brimming with molecules for this point in the season. The heating season is over, the cooling season is at least a month away and industrial and commercial demand is virtually nonexistent.

To wit, per the DOEs most recent Short Term Energy Outlook:

Total consumption of natural gas is projected to fall by nearly 2 percent in 2009, leading to lower natural gas prices. Industrial natural gas consumption is expected to decline by more than 7 percent, as industrial production declines during the current economic downturn.

Indeed, the woes in the global steel industry are well documented. Per last week’s story from the AFP:

  • Demand has dwindled and steelmakers, notably the giant of them all, ArcelorMittal, are damping down surplus furnace capacity while waiting for credit to flow, construction cranes to turn and factories to roll. In just months the global industry has gone from a boom driven largely by China, emerging markets and a property extravaganza in the Middle East to a narrow line between excess capacity and the costs of waiting for recovery.

Last month here in North America, U.S. Steel idled finishing and coking operations at its Hamilton and Lake Erie, Ontario Works, affecting 1,500 employees. The company has concentrated its production at its Mon Valley (PA), Gary (IN) and Fairfield (AL) Works. Output at its Hamilton (ON), Granite City (IL) and Great Lakes (ON) Works as well as at its Keetac iron ore field has been idled or is running at reduced rates.

The company consumed the approximate equivalent of 11,000 NYMEX futures contracts (110 ×1012 Btus) in 2008. That is not an insignificant volume. And, that is just one company. Now extrapolate extant mill shut-ins, from U.S. Steel to ArcelorMittal et al, and that is a lot of Btus that are not being consumed.

As such, futures traders continue to discount the NYMEX Board. For instance, the contango on cross-seasonal spreads is trending lower. Over the last month the discount on the October 2009 contract to the November 2009 contract has plunged from a low of 46 cents (0.912 ratio) to 64.8 cents (0.867) as of last night. As we analyze in today’s issue of The Schork Report, this spread has decoupled from the seasonal trend and continues to ape the 2006 price path. That is important because 2006 was the only season when we had more gas in the ground than today. More importantly, as far as next winter is concerned, the relationship between the winter strip (Nov’09 to Mar’10) and the following summer (Apr’10 to Oct’10) has decoupled as well.

Next winter is actually trading at a discount to the following summer, i.e. the ratio is below 1.0. That is the earliest that event has occurred in at least the last ten years. Bottom line, we appreciate that incremental production capacity is being scaled back. Per the Fed’s most recent Beige Book:

The Districts reporting on energy said reduced demand, high inventories, and lower prices led to steep cutbacks in oil and natural gas drilling and production activity.

Fair enough. Production is set to fall further. But in the meantime, the NYMEX Board continues to weaken. Steepening contangoes of seasonal spreads and strips are a clear telltale that the market is not concerned with supply relative to demand.

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Stephen Schork is the Editor of, "The Schork Report"and has more than 17 years experience in physical commodity and derivatives trading, risk systems modeling and structured commodity finance.