Nowadays you don’t even need to go to Vegas or Atlantic City if you want to gamble. You can just go trade natural gas. As we discussed in last week’s issues of The Schork Report, the natural gas rally is abnormally unstable… but it can remain abnormal longer than you can remain solvent.
Bank on that. For instance, last Friday there was a 67% chance that front-month gas would close above $3.766. It closed at $3.778. At the same time, there was a 67% chance that the Brent crude oil contract on the ICE would close below $73.03. It closed at $71.55. Thus, the New York natural gas futures market rallied by $3,200 per contract, while the oil contract in London closed down by $39.5 on an approximate equivalent Btu basis. In other words, natural gas is around 80 times riskier than oil right now. Part of this is due to the push and pull of natural gas fundamentals (which are overwhelmingly bearish) vs. technical indicators (which, as we shall see, where overwhelmingly oversold).
Technically, the bulls are hoping that the last two below normal EIA reports were such because of rising demand. Fundamentally, the bears think injections are low because we’re butting up against the peak working gas storage capacity, 3.889 Tcf per the EIA’s latest estimate. As should be clear by now, our sentiment lies towards the latter.
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Weekly injections of late have been lower than the seasonal mean, that’s a given, but the cause of that is not higher demand. The graph above shows the relationship between full storage capacity and weekly injections. At the start of May, only 56.9% of total storage capacity was occupied. As stage 1 (of 3) refills ramped up, weekly deliveries averaged 120% of their seasonal mean. A cool, wet summer in most market areas this season translated into more cubic feet available for underground storage. As such, storage hit 88.92% last week, its highest September value since 2006… and we are only halfway through the month. The relationship has an inverse correlation of (0.591) and the trend line clearly shows that as capacity approaches 100%, injections trend lower. That’s a fundamental argument which the technical traders simply ignore.
In the short term this myopia has caused a technical rally (fuelled partly by strong prices in 2006 despite capacity topping 95%), but will it lead to a bubble?
As capacity fills up and spare product floods the cash market, we think yes and we think soon. Prices collapsed last month because by September 1st storage is only allowed to reach 80% of capacity in the East. Last month we were butting up against that 80% limit, so all the gas being produced had to be sold because it couldn’t be stored, which led to a price collapse in the cash markets.
Once we passed September 01st and the 80% limit was suspended, suppliers began buying gas with cash because it was cheap. The futures market looked at that and mistook it for overly bullish sentiment, which explains the high prices today. But once we get to October we’ll be at (or pretty damn near) full capacity. Therefore we have a template, akin to what we saw in August, for another cash dump.
That’s the fundamental argument, but even the technicals are turning against the bulls.
The Relative Strength Index is used to measure whether a contract is oversold or overbought. As we can see in 2009 (see chart in today’s issue of The Schork Report), the contract was dangerously over bought at point 1, around August 10th, and dangerously oversold at point 2 around August 19th, which coincides with spare product flooding the cash markets. Moving forward, we see the RSI creeping upwards as an indicator that prices are once again becoming overbought. This pattern looks very familiar to the same timestep in 2006, which saw natty become overbought August 14th and oversold August 23rd.
Thus, if we can expect supplies and sentiment to follow ’06, we should be looking at natural gas becoming overbought by September 29th and falling by October as the fundamentals dictate. The bottom line is this bull rally will find it very difficult to sustain itself by next month. In fact, 2009 could be the first year we ever hit capacity, which, coupled with a milder than normal winter would send the cash markets in to freefall.
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.