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Schork Oil Outlook: Betting on NatGas Rebound? Be Careful

When we look at the May Nymex WTI contract’s 65% Confidence Interval (CI) of (74.80, 85.57), there are several logical interpretations, such as “One can be 65% confident that the contract will trade within 74.80, 85.57” or “65% of crude oil’s daily closing prints will be between 74.80 and 85.57.”

Analyst Hamza Khan explains the CI in today’s issue of The Schork Reportas “Given that prices are between 74.80 and 85.57, we can be 65% sure that the crude oil contract has the same behavior as when we calculated the metric.”

Thus a break outside of our CI often implies trend because a new external factor is influencing the behavior of the markets — whether that is the Total SA refinery workers striking in Paris or China altering the Renminbi’s peg to the dollar.

With that in mind, consider that the CI for the front month WTI contract in January was (74.47, 84.57), an average change of 0.81%. At the same time, the CI for natural gas was (4.865, 6.381). The current CI is (3.742, 4.007), an average change of 30.15%. The implication, is that it is not simply that natural gas prices today are trading at lower absolute values as they were in January, but that significantly different external factors are weighing on natural gas today than four months ago.

Consider that WTI traders are basing their strategy on consumer demand. An increase in jobs will lead to higher consumer confidence; consumers will buy cars, drive to work instead of riding the bus and take road trips instead of staying at home. Increased spending will lead to increased revenues and thus higher wages, allowing consumers to absorb higher prices at the pump.

This scenario scales on a global level: every economy follows the same template. But consumer demand remains a mystery, and has been so since the “recovery” began. Globally, we saw economies like Iceland sputter at the start of the recession, but recently Greece went through very similar woes and the possibility remains that Spain’s overinflated real estate market will lead to more of the same.

Domestically, consumer confidence remains at the same point since August. Temporary jobs have seen an increase but the total unemployment rate remains at the same level since August. Large revisions by the government have also left traders unable to discern the true state of the recovery and thus unwilling to bet that crude oil prices will trend in either direction.

On the other hand, natural gas prices are less sensitive to elastic consumer demand. When the weather gets cold, we have very few alternatives to turning up the thermostat. The 2009/10 winter broke snow-fall records and consumers reacted strongly, natural gas deliveries rose to an unprecedented 21.2 Bcf/d. Analysts assumed that traders would take this in to account — the signals could not have been any clearer — but traders are looking at a different signal.

At this point, natural gas is trading on a long-term skew. A lower rig count is no longer troubling because horizontal and directional drilling makes a large amount of natural gas available at rapidly diminishing costs. We will not need high natural gas prices to justify non-conventional drilling because the cost of technology is dropping at an accelerated pace.

As mentioned in previous reports, domestic shale reserves are high enough to dub America the “Saudi Arabia of natural gas.” Globally, Saudi Arabia isn’t doing too badly itself, neither is Russia or Qatar’s huge LNG capacity.

As illustrated in the Chart of the Day in today’s issue of The Schork Report, A paradigm shift has taken place. What was just a few months ago a theoretical long-term concern — the oversupply of molecules — is being priced in to the market today.

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Stephen Schork is the Editor of The Schork Reportand has more than 17 years experience in physical commodity and derivatives trading, risk systems modeling and structured commodity finance.