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A major cold pattern change coming late January into February offers a strong catalyst for the bulls and long positions in United States Natural Gas Fund (UNG), VelocityShares 3x Long Natural Gas ETN (UGAZ), and ProShares Ultra Bloomberg Natural Gas ETF (BOIL). Hence, the risk/reward does not favor the bears and those wanting to short the already deeply sold commodity.
Figure 5: 0Z Jan. 7 ECMWF Weeklies 500 mb Heights depicting a colder change to the pattern (Week 3) Jan. 21-28 time frame (Warm West US vs. Cold East US). GFS, GEFS, GEM amongst models that show similar pattern.
It's also worth mentioning the polar vortex. We've seen a Sudden Stratospheric Warming event take place already in late December. The polar vortex did not recover from that and as a result, has split into three separate vortices. This split has been showing up in the models for early January with a large chunk centered over the western/northern parts of Europe, another chunk over the U.S., and a smaller piece over the Pacific Ocean. Strong warming is also taking place in the polar caps. The key for investors is that this is not a forecast. It's already happened and it is being observed in the weather models. It usually takes a couple of weeks or so of seeing this propagate into the troposphere before impacts will be felt here in the mid-latitudes at the surface.
This, coupled with the weather models signaling cold, means that winter is not over - which fundamentally gives great upside potential for speculators in UNG, UGAZ, and BOIL. As things stand now, I'm giving a price target of $3.50 should this Arctic outbreak verify. (Figure 6 below shows this Polar Vortex split from January 6, 2019, depicted on the 06z GFS.)
Figure 6: Polar Vortex Split.
Currently, we have a weak El Niño in place. This has been a dominant player in our weather pattern, especially in December and the early parts of January. This El Niño, however, is not the typical El Niño we've had over the last few winters, neither in strength nor type. In a classic (typical) El Niño, Sea Surface Temperatures (SSTs) are predominantly warm over the eastern equatorial Pacific. We have a Modoki (central Pacific based) El Niño where SSTs are warm mainly over the central Pacific with bookend cooler waters over the eastern and western equatorial Pacific. According to analogs, this offers more of a colder risk for the U.S. as compared with the typical El Niño, as this type of El Niño (Modoki) has tendencies to at times send the jet stream into disarray (especially in mid- to late winter).
With that said, El Niño still has to be taken into consideration. However, the polar vortex split and the colder consistencies in the forecast models for late January into February can't be ignored. Given what we know about this year's El Niño (weaker, Modoki type) as compared with previous years, this year comes with a greater risk for cold outbreaks in the U.S.
Final Trading Thoughts - Gas Prices Expected to Rise, Storage Deficit Gap Expected To Widen
In summary, natural gas prices should hover around the $3.00 mark over the next week or so with bouts of both gains and losses. Upside potential then shifts towards UNG, UGAZ, and BOIL. Should the models verify, as we move further along in the month of January, natural gas contracts should go north of $3.00 upwards to $3.50 with UNG going above $25.00 and upwards to $30.00. The intensity and duration of the cold will be key. Should the cold pattern lock in (sustained Arctic air), prices will go higher than $3.50 and $30.00. For now, investors should plan to go long targeting $30.00 UNG or $3.50 front-end natural gas contract futures.
Regarding storage, the Energy Information Administration (EIA) on Thursday (Jan. 10, 2019) released its weekly natural gas storage report for the week of Dec. 29-Jan. 4. The report came in bullish with a net draw of 91 Bcf for that week, ultimately bringing storage levels down to 2,614 Bcf. That exceeded the consensus expectation of a 69 Bcf decrease. Even though the -91 Bcf was a bullish number, it was still much smaller than the five-year average of -182 Bcf and last year's number of -359 Bcf. This, as a result, helped to narrow the storage gap between this year's levels (which still remains at a five-year low) and the five-year average (Figures 7 and 8 below are both depictions of yesterday's EIA's natural gas storage report for the week of Dec. 29-Jan. 4.)
Figure 7: Thursday's (Jan. 10, 2019) EIA Natural Gas Storage Report (Table Format) for week of Dec. 29-Jan. 4, 2019.
Figure 8: Thursday's (Jan. 10, 2019) EIA Natural Gas Storage Report (Graph Format) for week of Dec. 29-Jan. 4, 2019.
There could be some additional slight narrowing over the next week or so. However, the gap between this year and the five-year average will widen, more placing additional pressure on reserves once the cold weather starts coming in later in the month.
Despite the bullish storage report, it did not have much of an impact on trading Thursday as investors/traders seemed more focused on temperature trends. It was similar to what happened after last week's report release from Friday, Jan. 4 where natural gas rallied 3% on expectations for cooler weather coming in despite the bearish EIA storage data. This type of reaction would further lend support to UGAZ and BOIL.