The fundamentals have not changed… they’re as bearish as ever. We know that. Everyone knows that. The bulls have been backed into a corner. It is time for them to put up… or shut up.
Yesterday the EIA reported that working gas in underground storage increased by 66 Bcf or 2% to 3.46 Tcf for the week ended September 11th. It was a very low injection. For instance, a year ago for the corresponding week approximately 49 Bcf of GoM gas production was shut-in as result of hurricanes and power generation was 5,485 GWhrs (6.8%) greater, yet this year’s injection was only 3 Bcf larger.
Injections typically trend higher in September as cooling demand moderates. However, in a typical year storage is not pushing up against capacity. In light of reported transportation and storage constraints, injections this month will be low by historical standards; hence the last two injection reports.
Are constraints bullish and are they the reason why spot Henry Hub gas rallied from a low of 2.74 to a high of 3.90 (+42%) in between the last two EIA reports? No.
Last week the EIA noted that weak demand from the industrial sector over the U.S./Canada Labor Day holiday “…added to the growing surplus of supplies on pipeline systems and in storage fields, reducing pipeline companies’ flexibility to handle imbalances on their systems… citing high working gas inventory levels, Texas Gas Transmission, LLC, announced to shippers that the pipeline will be unable to accept interruptible storage injections effective September 5 until further notice. Any supplies currently on the system as a result of imbalances in scheduled receipt and deliveries must be cleared by September 30, according to the pipeline company.”
In another report, El Paso Natural Gas Company reported that it experienced “…high linepack condition as a result of actual takes below scheduled quantities and receipts from its supply basins in excess of scheduled deliveries.” In other words, the pipelines are telling us that they are having a hard time of getting gas into the ground. As noted last Friday, in late August several Northeast pipelines had to issue operational flow orders (OFOs) in an apparent attempt to hold storage below the September 01st ratchet. Without the ability to push GoM gas up the pipe, gas at the Henry Hub dropped below $2 through the holiday weekend.
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Last night October Henry Hub gas settled at $3.458 and the 10-day volatility surged to 142%. That means there is a 33% chance this contract will settle either above $3.766 or below $3.150 today. We have not seen volatility like that since Amaranth imploded three years ago.
Thus, if you want to tell us someone has blown up in this market over the last month we will believe you. We cannot help but think that that plunge in cash values plus the pending roll of the UNG encouraged speculators to take on extra downside exposure in the spot month. Therefore, someone, like a deep-pocketed hedge fund manager, recognized this exposure and began taking appropriate measures last week to ignite a short-covering rally. It worked.
Bottom line, the fundamentals are as bearish as ever. Our friend Alan Lammey at Natural Gas Week noted that a significant amount of production, which was shut-in when gas had a $1-handle, was hedged over the last week. If pipelines are having difficulty handling transportation today, what are they going to do in October? Therefore, the table is set for another move lower in the cash market at the Henry Hub next month.
The only question is will the NYMEX follow the fundamentals or will it continue to blaze its own path?
Here at The Schork Reportwe think it will be hard for the NYMEX to ignore the fundamentals, but as we saw in 2006, this market complex has an uncanny ability to remain deaf, dumb and blind. After all, three years ago underground storage went into the winter with a then record 3.46 Tcf in the ground. At this point in 2006, while Amaranth was blowing up, gas for delivery that winter was trading virtually on par to the following summer and at 16% discount to the 2007/08 winter. In other words, at this point in 2006 the market was not concerned regarding the availability of molecules for the pending heating season.
However, thanks to a brutal winter and strong industrial demand, gas rallied that winter. Today the curve is even more bearish. This winter is trading at an 8% discount to next summer and at a 23% discount to next winter. So, once again the market is showing little concern for supply, relative to demand expectations. However, industrial and commercial demand is a shell of its former self compared with 2006. Thus, if we are going to see a repeat of 2006, then we are going to need another ice age this winter. And, according to the latest outlook from the International Research Institute at Columbia University, the bull’s odds are rather long.
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.