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Schork Oil Outlook: The Fundamentals Just Aren't There

Gas production is trending lower, but in light of the pullback in rig counts, it is occurring at a snail’s pace. For example, the year-on-year deficit in gas rigs has been greater than 50% since May; yet onshore production (ex Wyoming) is only down by 0.6% through July. Thus, the proliferation of non-conventional drilling and a rebound in LNG has been enough to offset a large portion of shut-in conventional output. As a result, gas is still getting into the ground vis-à-vis domestic production and imports. More importantly, the extant contango on the NYMEX continues to pay producers to build inventory.

Further to that point, imports of LNG have been on the rise, especially from Egypt. While pipeline imports from Canada through July are down 11% this year – a statistic that dovetails with the dearth of Canadian rigs this spring and summer – waterborne imports of gas are up 41%.

As the EIA notes, demand is still poor. On one hand, steel production has been trending steadily higher since the start of the year. According to data provided by the American Iron and Steel Institute (AISI), weekly U.S. steel production hit a year-to-date high at the end of September, 1.39 million tons. That is a good sign, but that is still 25% below the 2008 average. As of 2002, the latest year for which the EIA has data, U.S. steel mills consumed the equivalent of 8.9% of the average open interest of the NYMEX Henry Hub natural gas contract, 417 trillion Btus. All told, aggregate metal production (ferrous and nonferrous) in the U.S. is 33% less than it was in 2002.

Meanwhile, chemicals production, the other major heavy industrial end-user of natural gas, is about even to 2002. That’s important, because there is a growing consensus in this market that appears to be buying into a recent bullish winter weather forecast by a prominent meteorologist.

In this light, analysts at The Schork Reportran some numbers against the 2002/03 winter, which as we recall, was brutal. All told, heating degrees were 7% above normal that season. As a result, underground storage fell 7% below the seasonal average. If we continue an autoregressive forecast for this winter’s stocks, we will end up 13% above the seasonal average; so even if heating degree days do come in at 2002-03 levels, we are still going to end this winter with an overhang of Btus.

To really make a difference, this winter will have to generate heating degree days 20% greater than the DOE’s latest STEO assumption.

Bottom line, production today is greater, as are imports and demand is weaker than it was seven years ago. Therefore, fundamentals do not explain the current runup on the NYMEX; but falling open interest and slack volume do… the shorts are covering.

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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.