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Schork Oil Outlook: Prepare for an Interesting Winter

As we have discussed ad nauseam, nat gas injections typically trend higher in September as cooling demand moderates. However, this year’s normal path is skewed by storage constraints, e.g. operational flow orders from high linepack conditions resulting from above scheduled receipts in supply basins and below scheduled offtakes in consuming market areas.

In other words, producers are having a hard time pushing gas up the pipe. In this light, we are of the opinion that low injections are a reflection of the glut of molecules and therefore inherently bearish from a nearby fundamental view… nearby, as in gas for delivery in the month of October.

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But, the view on the NYMEX is obviously different. We believe the “strength” currently underway in the Henry Hub futures pit is a function of deleveraging by oversold bears wary of pending CFTC legislation, rather than a legitimate fundamental view. Whatever the reason, the post Labor Day movement has generated a tremendous spike in volatility.

If we look ahead through this winter towards the first NYMEX contract of next year’s refill season, April 2010, approximately 120 trading sessions from today, the 120-day historical volatility is 32.4%. Meantime, implied volatility is around 47% and the long term mean volatility in the April contract is 42.9%.

As we illustrated in today’s issue of The Schork Report, implied volatility (the market’s guess) is well above the long term mean and historical volatility is well below. As such, options traders are pricing in considerable risk in the April contract. What’s more, given the mean-reverting nature of volatility, there is a good chance historical volatility will rise towards its long term mean over the next 17 weeks towards the April 2010 expiration.

In other words, this is going to be an interesting winter in the Henry Hub pit. The NYMEX winter strip (X09-H10) has been trading at a discount to next summer (J10-V10) since the spring. This is a rare event. However, the spread has tightened, as you would expect given the ongoing technical spike.

We understand there is a growing consensus in the weather geek community that odds are shortening that this winter could be the coldest yet of the decade; even colder than the 2002/03 winter, which if you recall, slammed the East, but for the most part, spared the Midwest.

More importantly, some forecasts for this winter have the cold extending from the East out through Chicago, the largest residential gas market in the U.S. As hard as it might seem to be, the tightening in the winter/summer spread could be a reflection of the market’s growing concern regarding the availability of molecules for this winter. On second thought, we will stick with our initial assessment… the run-up in price is a function of deleveraging by overly enthusiastic bears.

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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.