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This Might Be The Last Great Opportunity To Go Long Natural Gas

Natural gas has tumbled 21% during October to lows not seen since the supply glut of 2012 despite only an historically small storage surplus amidst fears that storage will reach capacity.

My calculations show that not only will natural gas storage not reach capacity this year, but that it is highly unlikely to do so next year.

As a result, I believe that the commodity is trading at a significant discount that leaves it open to a 50% + rally in coming months.

This article analyzes the current supply/demand balance in the natural gas sector as it relates to natural gas price. My trading strategy based on this data is discussed in detail.

Friday's 3% rally aside, the past month has been a non-stop victory lap for natural gas bears. The commodity closed Wednesday at just $2.03/MMBTU, down 21% for the month and was briefly trading under $2.00/MMBTU for the first time since 2012. Thanks to contract rollover and a 3% relief bounce, the commodity closed Friday at 2.31/MMBTU. Truly, the past year really been one giant victory tour for bears with natural gas down 40% over the past year and 65% since reaching decade-highs over $6/MMBTU during January 2014. Figure 1 below shows the price of natural gas over the past year.

Figure 1: Natural gas spot price over the past year showing accelerating decline into the fall with prices bottoming out near $2.00/MMBTU. [Source: Chart is my own, data from: EIA]

While the bears remain firmly in control, I believe that they have far extended their hand and fear-driven panic-selling has led to a significant undervaluation of natural gas. This article outlines the current natural gas supply/demand picture and argues that natural gas is significantly undervalued at current levels and is poised to rally.

Last Thursday, the EIA reported that natural gas storage for the week ending October 23 increased by 63 Billion Cubic Feet (NYSE:BCF) to 3877 BCF. Figure 2 below plots total natural gas storage for 2015 to-date versus the 5-year average and 5-year maximum.

Figure 2: Natural gas storage versus the 5-year average and 5-year max showing slowly building storage surplus. [Source: Chart is my own, data from: EIA]

Figure 3 below plots the departure versus the 5-year average against natural gas price for 2015.

Figure 3: Natural gas storage departure versus the 5-year average versus price showing a negative correlation with falling prices associated with a rising surplus. [Source: Chart is my own, data from: EIA]

As these two charts show, natural gas started the year at a 67 BCF storage surplus deficit suggesting a tighter market but has transitioned to 153 BCF storage surplus over the last 10 months. As the market loosened up over the summer, the price of natural gas fell, with this decline accelerating sharply as the surplus built into the Fall.

This all being said, we're talking about a 153 BCF here, folks, just 4.1% above the 5 year-average. How rare is it for natural gas storage to be 153 BCF or more above the 5-year average? Not rare at all. Of the 261 weeks this decade, the natural gas storage surplus has been 153 billion cubic feet or more during 117 or 45% of those weeks--nearly half the time. And during those 117 weeks, the price of natural gas averaged $3.46/mmbtu, a 50% premium to Friday's closing price. The last time that the price of natural gas traded as low as current prices was during the spring of 2012 when the storage surplus was as high as 925 BCF, 6x what it is presently, making such low prices justified.

Figure 4 below plots the storage surplus or deficit versus price for five years from 2010-2014. The red dot represents the current storage/price datapoint.

Figure 4: Natural gas storage versus the 5-year average plotted against price showing a generally linear relationship. The current surplus vs price data point, as represented by the red dot is a significant departure from its predicted fair price (gold dot). [Source: Chart is my own, data from: EIA]

While the data set becomes congested when storage is within about 250 BCF of the five-year average, it displays a linear relationship at high and low prices and storage surpluses/deficits. It is obvious that the current data point is a significant deviation from the traditional relationship. Based on this data, a storage surplus of 153 BCF equates to an estimated "fair price" of $3.74/MMBTU, a 62% premium to Friday's close (the gold data point in Figure 4).

Given these theoretical premiums why are investors underpricing natural gas so much? In the short term, a source of concern for natural gas investors is undoubtedly the approaching peak of the storage injection season. Last week's storage level of 3877 BCF is tied for the fourth largest value on record. I project that there are two more weeks remaining in the storage injection season and expect storage levels to peak at 3975 BCF before the withdrawal season begins. Given that last summer many were predicting natural gas storage to peak well over 4000 BCF, this is actually a small victory for the bulls. Nonetheless, peak storage of 3975 BCF would handily beat the previous record high storage level of 3929 BCF set in 2012. For what it's worth, during that previous record high, natural gas was trading at $3.55/MMBTU, a 54% premium to current...


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