I'm Bullish on Natural Gas

 | Jun 13, 2017 | 11:00 AM EDT
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Natural gas prices crashed 15% in May as speculators bailed out of long positions. They were net long 283,000 contracts of NYMEX natural gas in the week ending May 16. It's now down to only 123,000. Look at the chart below. You can see the impressive liquidation that has occurred.

Total open interest in NYMEX natural gas also dropped to 1.48 million from 1.56 million in the week ending May 16. So, a lot of traders have left the market in the period.

There are other things coming together for natural gas, besides the market composition that I just told you about. For example, there is the diplomatic and commercial "war" between Qatar and the states of the Gulf Cooperation Council. If you haven't heard about that, it's Saudi Arabia, UAE, Egypt, Libya and other gulf states cutting off all diplomatic and commercial ties with Qatar. This is important because Qatar is a major producer of natural gas and now the blocking of borders and commerce lines makes the transit of Qatari natural gas more complicated. While we haven't seen much of a reaction so far, things could easily "back up" if the row continues long enough.

Then there's weather. The weather's been brutally hot through much of the U.S., especially here in the northeast. Natural gas is used extensively for electricity generation, and hot temperatures mean more air conditioners running overtime. Electricity demand goes way up and with it, demand for natural gas.

Weather is also a factor in this year's hurricane season forecast. Big storms can have a huge impact on gas production if they threaten rigs that are operating in the Gulf of Mexico. This year is supposed to be one of the busiest hurricane seasons on record. The National Oceanic and Atmospheric Administration (NOAA) expects 11 to 17 named storms in the Atlantic basin -- more than the 30-year average. Even the threat of storms is likely to cause speculators to buy natural gas futures, and that'll jack the price up.

In addition to weather and geopolitics, there is the factor of rising U.S. liquid natural gas (LNG) exports. Exports have risen four-fold in the last five years, and much of that is really just starting to happen in the past year. We are seeing LNG exports explode. Last week, the White House announced the first shipments of U.S. LNG to Poland and the Netherlands.

World gas prices are two to three times what we have here domestically, so increasing exports are sure to make the domestic price converge toward the global price of natural gas. Granted, that effect is longer term, but you shouldn't discount it that much. It will be a constant support for the market.

On the domestic production side, the Energy Information Administration forecasts a slight uptick in natural gas production this year from the decline that we saw in 2016. That was the first decline since 2005, however the increase this year will not be major. Only 1 bcf/day added to the 73 bcf/day currently produced. EIA is also looking for a price rating from $2.31/MM/Btu to $4.41/MMBtu. My guess is we'll see a price closer to the high end.

It all adds up to a very favorable risk/reward scenario, I think. Gas prices are cheap right now, having come down in that selloff I mentioned earlier. Perhaps we have $2.80 as a downside risk, but above $4 as we move through the rest of the year.

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