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Schork Oil Outlook: How Long Can Bearish Action Hold?

Yesterday the EIA reported that working natural gas in underground storage in the U.S. fell by 172 Bcf or 8½% to 1.85 Tcf for the week ended February 19th. It was yet another large delivery from a seasonal perspective, but we are certainly used to that by now. The typical delivery is 100 ±13 Bcf. Last week’s triple-digit pull was the smallest of the last three reports, but it is definitely not going to be the last.

The typical delivery for next Thursday’s report is 84 ±11 Bcf. However, with temperatures this week in Chicago averaging around 29°F (-1.7°C) and the Northeast currently getting hammered by what AccuWeather has dubbed a snowicane (get it? …snow + hurricane), odds are once again short we will see another delivery well in excess of the century mark. More to the point, yesterday’s report was the last in which the odds favored a three digit delivery, i.e. over the last 15 years, the EIA reports a total of 8 ?100 Bcf deliveries for the period ended last Friday.

In this light, there should be little doubt that we will challenge the record deliveries for the next two reports. Yet, NYMEX bulls are struggling to defend the 4.595 life-of-contract low in the April Henry Hub futures contract. Amazingly bearish action, but how long can it last (?) …long enough. At some point we are going to want to own this market, provided we can sell WTI against it. However, we are not at that point yet; after all, crude oil on the NYMEX is currently only yielding a 60% premium to the Henry Hub contract.

The Schork Report said it last week and we will say it again… with the current pace of deliveries this winter, end-of-season storage could test the 500 Bcf threshold next month. The odds are long, but there is a chance nonetheless.

Odds are better though that we could test 525 Bcf. The five-year minimum, according to the EIA’s interpolated estimates is 487 Bcf. We are however comfortable with the notion that GoM stocks will enter refills with somewhere in between 549 and 572 Bcf still in the ground.

Bottom line, we learned nothing new yesterday as the EIA report came in as expected. The weather outside remains frightful, but the NYMEX does not care. That is to say, the contango along the term structure of the Henry Hub futures contract is flatter than a year ago. But then again, a year ago the global economy was circling the bowl. The point is, the market is still in contango (see above), i.e. the market is still discounting spot molecules amidst one of the coldest, snowiest winters ever recorded.

Now look at the term structure for this point in the winter back in 2008 and 2007. Whereas today there are only 893 gas rigs employed according to Baker Hughes, in 2008 there were 1,430 gas rigs and 1,472 in 2007! Yet, the markets at the end of those seasons were in steep backwardations. For instance, last night spot gas for April delivery settled at $4.767 and you could have locked in next winter’s gas at $5.882 and the winter after that (2011/12 season) at $6.40.

That’s a far cry from just two seasons ago.

Back at the end of the 2007/08 winter spot gas for April 2008 delivery was trading at $9.854, but the market was giving you a deal [sic]. Whereas you had to pay up to own spot gas, you could have locked in future gas at a bargain… gas for the 2010/11 winter, two years ago was only $9.278 and for the following 2011/12 winter, it was even cheaper, $9.229.

In other words, two years ago the market was charging a premium to own gas (i.e. nearby summer gas was dear to the following summer and nearby winter gas was dear to the following winter). That only happens when demand is strong relative to supply… and that is the definition of a fundamentally bullish market… unlike the market we have today. Today the market is discounting nearby gas. That can only happen when demand is weak relative to supply… and that is the definition of a fundamentally bearish market.

This market will rally, eventually… when industrial and commercial demand returns… and not until then. Because as we just saw this winter, the weather is not nearly enough to scare the bears.

Last week The Schork Report commented how the bulls were scrambling to defend $5, today the bulls are scrambling to defend the $4.595 life-of-contract low in the April. Next Friday we will probably be talking about how the bulls are trying to defend the October 28th/September 28th gap on the continuous chart from $4.230 to $4.035.

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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.