It’s Getting Hot in Here So Take Off All Your…Hedges

Okay, so that’s a small exaggeration, nor is it my advice, but the title was catchy. But the heat is indeed back. I’ll get to that in a minute. First, the tropics. Once again, there isn’t very much to talk about.  The Weather Gods have blessed the Atlantic with calm winds, clear skies, and dry, dusty air. The tropics are seriously quiet, with no noteworthy waves to discuss. I give a less than 10% chance of seeing a named storm in the upcoming week. Once again, not terribly unusual for the second week of July. The latest satellite imagery for the tropical Atlantic shows only spotty convection, none of which is organized around any sort of low pressure center.

Figure 1: Current satellite of the North Atlantic showing quiet conditions

Some of the computer models are beginning to indicate that things may start to pick up in the next couple of weeks. It appears that the Inter-Tropical Convergence Zone (ITCZ), or the area of converging winds along 10N, will become more active beginning late in the week. This region often serves as the spawning ground for tropical cyclones. Even today, sustained convection can be seen in this area around 45W.  Other models  develop upper-level anticyclones in several areas across the Atlantic. These are favorable features that allow hurricanes and tropical storms to “vent” as they organize. If a hurricane is a giant heat engine, then an upper level anticyclones is the radiator.

Of note, the eastern Pacific has spawned hurricane Carlos, the first hurricane in that basin this year. The storm is heading towards open waters and cooler temperatures, and will soon begin to weaken. Activity in the Western Pacific has picked up as well with Soudelor making landfall in northern Vietnam this morning as a minimal Tropical Storm.

Also, on July 9th, the National Weather Service officially announced the arrival of El Nino. El Nino is characterized by a warming of the eastern Pacific equatorial waters that serves to increase wind shear across the Tropical Atlantic and reduce the number of tropical cyclones. However, due to its late arrival, I do not believe this year’s El Nino will substantially affect the peak of hurricane season (August and September), but will rather result in an early conclusion, perhaps by early to mid October, rather than early November.

Temperatures

The “Ridge of Death” that has been delivering consistent warmth to south Texas for the past two weeks will continue to expand this week, bringing triple digit heat to areas of the south as far north as Kansas, and 90 degree heat to most of the southeast and southern Midwest. As whole, the nation will be substantially warmer this week, compared to last. While I wouldn’t go as far as calling it a Heat Wave, most areas south of the Mason-Dixon Line will be comfortably above average.  Figure 1 below shows the projected total Cooling Degree Days (CDDs) from July 12-17. Note: the figure shows the predicted CDDs for each county. That is, if you are anywhere in that county, you can expect, on average to see that many CDDs in the upcoming week. For an explanation of cooling degree days, see my post from last weekend.

Figure 2: Projected Cooling Degree Days for the Lower 48 for the upcoming week.

Figure 3 below compares this week’s forecast to last week’s total CDDs.

Figure 3: Projected change in Cooling Degree Days between this upcoming week and last.

Based on Figure 3,  most of the nation will be warmer than last week. In particular, the Southeast from Texas through Virginia can expect to see extensive warming. The warming will be concentrated in Arkansas and Oklahoma, where these areas will gain up to 40 cooling degree days compared to last week. This means that, on average, both the daytime highs and nightime lows will average between 6 and 7 degrees warmer than last week. The Sacramento Valley in California can also expect to be solidly warmer this week. The only areas seeing any extensive cooling will be a small area in the upper midwest including the Dakotas and Minnesota. Table 1 below indicates that the nation as a whole will see roughly 19% more cooling degree days this week from last week.

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Table 1: Projected Cooling Degree Days across the Lower 48 for Upcoming Week

	Week Ending July 10 (Last Week) Observed	Week Ending July 17 (This Week) Forecast	% Change
East	87015	108623	+24.8%
Producing	74557	89519	+20.1%
West	19503	16694	-14.4%
U.S. Total	181075	214836	+18.7%

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What does this mean for electricity demand and energy consumption? In terms of natural gas consumption, it matters less that there are lots of Cooling Degree Days and more that areas of high population density are suitably warm. Having 60 CDD/day in Death Valley where nobody lives will be less significant than having 30 CDD/day in New York City. Thus, I have taken the numerical data I generated  and weighted it based on the population of each county.   Weighted observed CDD data for the past two weeks and weighted forecast data for this week is shown below in Table 2.

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Table 2: Projected Weighted Cooling Degree Days and Natural Gas Injections for the Next Two Supply Reports

	Obs. CDDs Week ending July 3	Obs. CDDs Week ending July 10	Projected CCDs Week ending July 17	Obs. Injection Week of July 3 (Released July 9)	Projected Injection Week of July 10 (Released July 16)*	Projected Injection Week of July 17 (Released July 23)
East	2665.9	2875.7	3417.5	+60	+55.6*	+46.8
Producing	1602.8	1651.9	1915.7	+12	+11.6*	+10.0
West	1276.3	1107.4	1272.1	+3	+3.5*	+3.0
U.S. Total	5545.00	5635.0	6605.3	+75	+70.7*	+59.8

*Does not take into account the 4th of July Holiday which will reduce demand

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Table 1  shows that, compared to the past two weeks, this week will have roughly 18% more population-weighted CDDs compared to the past two weeks. The greatest increase will come in the East, with a 28% increase while the greatest decrease will come in the West. It is interesting to note that in the Western Region, projected population-weighted cooling degree days will increase by 15%, while in Table 1, which did not weight the counties by population, this number decreased by 14%. This discrepency derives from California (which is predicted to be much warmer week-over-week) having a substantially higher population density than the Northern Great Plains ( which are expected to be cooler), despite the latter have a greater area.

I have also included projection figures for the next two natural gas supply reports based on these temperature patterns, which are rather crude estimates as natural gas demand does not always vary on a 1:1 basis with temperature. This week, in particular, is a good example. While the CDD data predicts a small drop in injections, supply reports will likely show a large increase in injections due industrial and commerical shutdowns on account of the 4th of July Holiday (BBQ Grills burn propane, not natural gas, so no help there). However, such projections are useful in showing a trend. With increasing temperatures for the next two supply reports (last week and this week’s forecast), I do not expect any greater-than-expected injection surprises.

I am net long on Natural Gas (UNG) right now, with a small position in DTO (x2 short Oil) as a hedge. I am also holding Valero Refining (VLO) short. Should the global market appear week this week, I will look to add additional oil shorts.

On the long side, I may look to add retail longs. Rainy weather in the northeast in May and June put a damper (ha ha) on sales of bathing suits, bikinis, etc. and has resulted in these stocks getting hammered in the past week. Sunny and warmer weather may result in some quick sales for July and August. Right now, I’m looking at Gap ($GPS).

Figure 5: Gap. I know the technicals suck.

Note: Major Karma Points to the first person to correctly identify the hurricane shown at the top.  This is going to be a common theme of posts for the foreseeable future. A small hurricane warning flag will be awarded to the individual with the most points at the conclusion of the hurricane season, provided that they have at least 12.

An additional point to the person who identifies the unfortunate island sitting in the storm’s eye.

Wabisabi currently leads Dpeezy 3-2. You guys need to step it up. Wabisabi has gotten 3 straight, and is threatening to run away with it.

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While I hate to keep pounding the natural gas drum, here it is, as it will be every Friday of my term. The purpose of this post is not to pump UNG, but simply to lay out the numbers and some simple analysis.

The EIA released its natural gas supply report yesterday for the week ending July 2 and showed a 75 BCF injection into storage. For those unfamiliar with the commodity, natural gas is injected into old salt domes and empty oil wells with good seals during a summer storage season running from April through September. Most natural gas consumption occurs during the winter withdrawal season when it is used for home heating. Anyways, while this 75 BCF injection was greater than the projected +71 expected by analysts, it is a substantial drop from just a few weeks ago when injections of >100 were frequent. It was also 17% less than the +90 BCF injection that is average for this week, and was less than the +89 BCF injection from the same period last year. Nevertheless, supplies are still running extremely high, more than 19% above the five year average. Below is shown a two year chart of the injections and withdrawals showing our above average-ness.

Figure 1: Natural gas storage for the past two years.

The are four possible explanations for the drop off in recent weeks.

1) A pickup in demand

2) A falling rig count

3) Cuts in production

4) High Temperatures–Bingo. Summer is here. Case closed, right? Maybe, maybe not.

Let’s see.

Studying temperature trends can tell us a lot about the commodity and its direction. Temperatures across the nation were highly polarized for the week ending July 2nd. The northeast and northern Midwest were colder than average while the southeast and west coast were above average. This is the way that it has been for much of the summer . The maps below show this disparity.

 

Figure 2: Temperature trends for the week ending July 2, showing cooling than average temps in the Northeast and warmer than average across the south and west.

 

The numerical data shown below in Figures 3 and 4 supports the affect of temperatures on NG injections. The northeast was cooler than average (and just generally cooler) and thus had the largest injection, while the west and producing regions saw the smallest injections. Not terribly surprising.

However, a comparison of this data to last year’s injection numbers points to some discrepancies and indicates that other factors may be involved. For example, the west coast saw a -12 BCF, or 80%, reduction in injections compared to last year, despite a mere 6 CDD increase, or just 4%. The eastern region saw injections decrease by one, despite average 38 CDD cooler compared to the same period last year! While there is certainly a maximum injection regardless of temperatures, injections in the east have exceded 70 BCF on numerous occasions.  Understandably, NG supplies and CDDs do not follow one another in step. However, seeing such a deviation indicates changes in supply or demand outside of cooling demand.

 

Region	CDD Last Week	CDD From Average	Change in CDD From Last Year
East	152	-25	-38
Producing	330	+41	+43
West	132	+29	+6
U.S. Average	69	+5	+2

Figure 3: Comparison of Cooling Degree Days (CDD) for this past week and the same period last year for three regions.

 

	Injection This Year (BCF)	Injection Last Year (BCF)	Change (BCF)
East	+60	+61	-1
West	+3	+15	-12
Producing	+12	+14	-2

Figure 4: Comparison of injection numbers for this past week and the same period last year for three regions.

So, what to make of this data?  Re-examining the the four options listed above, we  first consider the rig count.  Baker Hughes reported this morning that the rig count fell 16 to 672 in the past week, the lowest that it has been since 2002. It is down 872 rigs from the same date last year, or 57%.

Figure 5: US NG Rig Count

For clarification, these are drilling rigs, not producing wells. Thus, cutting the rig count does not result in an immediate drop in production. Rigs that were drilled last year continue to produce. Thus, one must wait for gas pressures to decrease in these wells before a drop in production is observed. In the U.S., 30% of natural gas comes from rigs drilled in the past 12 months.

  Unfortunately there is a lag in production data. However, in April the US produced 2.189 Trillion BCF compard to 2.132 Trillion Cubic feet in Aril a year earlier, indicating that production had not declined. During this period, the rig count was in the 800s. Generally, a rig count under 800 is expected to result in eventual declines in production. Earlier this year, Chesapeake Energy projected that if the rig count stayed steady at 750 through 2009 that daily production in the U.S. will fall from around 62 BCF/Day to about 52 BCF/day. While the rig count continues to fall, it has shown signs of nearing a bottom, and I don’t expect it to fall below 625.

Perhaps the rig count is finally coming into play, but I do not think it is solely responsible for the CDD:temperature discrepancies.

I believe that the lower injections also derive from a combination of cuts in production as well as near-site storage. With the price of gas at under $3.50 MMBTU, few companies can generate a good profit producing. Chesapeake and Anadarko, two of the leaders in new unconventional drilling techniques, both have a $6.00/MMBTU drilling cost. Thus, many companies must cut output in order to preserve capital. While complete figures aren’t freely available, Chesapeake has announced that it is cutting its production by 13%, or 400 Million Cubic Feet/Day.

Production cuts aren’t really a good thing. Companies must drill regardless of futures prices in order to maintain leases on gas-rich lands. Thus, it is likely that many of those 672 rigs are drilling a well and then immediately capping it, effectively storing the gas in its own reservoir. Should supplies begin to fall and prices rise, the taps can be turned on on very short notice, damping a price spike.

Due to the lower than expected numbers on the east coast, I believe that the Marcellus Shale Field, located in the central Appalachians, has either succumbed to the falling rig count or production cuts.

Elsewhere, I believe that companies are cutting costs by storing some of their product on-site rather than paying additional transport costs. The majority of US natural gas is produced from large fields in the South Central part of the nation, namely the Haynesville, the Fayetteville, and the Barnett Shales. Thus, rather than pay for transport costs, some of this gas is being pumped into storage in the south. The producing region, which experienced the greatest warming year-over-year (+43 CDD, or 15%), saw only a 14.3% reduction in injections, implying that additional gas was injected despite the cooling demand. While this gas could eventually be shipped to markets in the U.S., I believe that there is a possibility that some of this gas may be liquified into LNG and shipped to foreign markets. Last month Chenniere Energy, an LNG importer, received government approval to convert its Sabine Pass LNG terminal into an export facility. The plant has a capacity  of 2.4 BCF per day.

 

Outlook

Should supplies build for the rest of the injection season at an average pace, storage will peak at 3866 BCF, more than 300 BCF over the previous record of 3540 BCF set in 2007. It has been projected that the maximum storage capacity of current fields is 4030 BCF. However, since this number has never been approached, nobody knows for certain how much gas can be injected. I do not believe we will see an injection over 3800 BCF and feel that the combination of cuts in production, increased cooling demand from a warmer than average summer, the falling rig count, and hurricane-induced shut-ins will cause storage to peak at no more than between 3600-3700. I will have a full post discussing storage projections in the near future.

As for trading, I am beginning to unwind my NG/Oil pair trade. I sold half of my DTO oil short yesterday at $96.00 for a 33% profit, and will look to unload half of my remaining position should it hit 105. I will likely hold on to the remaining 1/4 position for a time. I realize that I may be too early in undoing this trade, but I am concerned about holding leveraged ETFs for an extended period of time. Just take a look at FAZ and FAS. Plus, a 30% profit is a 30% profit. I am not adding to my UNG position at this time after buying a small quantity at 12.40-12.50 earlier in the week. I now have a cost basis of 13.70 on the position, with the pair trade as a whole being solidly in the black. I am also holding a VLO short from 17, due to its technical break of long term support and an unfavorable crack spread.

 

 

Note: Major Karma Points to the first person to correctly identify the hurricane shown at the top. This is going to be a common theme of posts for the foreseeable future. A small hurricane warning flag will be awarded to the individual with the most points at the conclusion of the hurricane season, provided that they have at least 12. 

Wabisabi and Dpeezy are currently knotted at 2-2.

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The supply glut continues as the country is awash in crude. The EIA released its weekly Petroleum Supply report this morning, showing that crude supplies fell 2.9 Million Barrels from last week while Gasoline supplies increased 1.2 Million Barrels. Both of these exceeded analyst expectations, who were anticipating a drop of 3.2 Million Barrels and an increase of only 900,000 Barrels, respectively. This continues to illustrate that demand has not returned and $60 crude may still overvalued. Shown below in Figure 1 is the weekly Crude supply for the past two years.

 

Figure 1: Crude oil stocks for the past two years, showing supply glut

Perhaps most expository of these high supplies is the increase in gasoline stocks (refined crude). Stocks this week were 33% above that predicted, and have been steadily increasing in recent weeks, despite July and August being the season of peak demand. This is due to refineries running at low capacity, roughly 5% below average for this time of year. Both gasoline and refinery capacity are shown below in Figure 2 and 3. Apologies for the poor graph presentation. I just had my butt kicked by a foreign Mac.

 

Gasoline Supplies (In Millions of Barrels)

Figure 2: Gasoline supplies for 2009 versus the 5 year average showing a rapid increase in supplies in the last month.

Refinery Utilization (%)

Figure 3: Refinery utilization showing refineries operating roughly 5% below their five year averages.

This low refinery capacity is largely due to an unfavorable crack spread. The crack spread is the difference between the input costs (crude oil) and the output sales (gasoline) of the refining process. Due to increased crude prices on speculation that the economy would recover, and comparatively static distillate prices due to a continued low demand, the crack spread under 10, which is low for this time of year. 

As a result, shorting the refiners appears attractive in the short term. Both Valero (VLO) and Western (WNR) have recently broken through long term support. I am short a small position in VLO from 17.00 and may look to add more on a bounce. Both have been beaten down recently, so beware of an oversold rally.

 

Figure 4: Short candidates

In addition to the small VLO position, I am long DTO (x2 short Oil ETF) from 72 as the second half of my paired Oil/NG trade. That hedge is working quite well today. I will look to begin closing the DTO position when oil falls below $60, probably between 95-100.

 

The Tropics

For the most part, the tropics remain quiet. An area of convection has flared in the western Caribbean, but is not an immediate threat to develop. However, climatologically this is a region where storms frequently originate in early July and thus will have to be watched. Additionally, some of the computer models are pointing to some possible development between Africa and the Lesser Antilles late this weekend. This area is not climatologically favored this early in the season, but the runs have been displaying some consistency and thus this too needs to be watched.

 

Figure 6: Latest infrared satellite of the tropical Atlantic showing generally quiet conditions. The flare-up off the Honduran coastline is of minimal threat to develop.

One last thing to note, the Western Pacific has been abnormally quiet this year, with only 4 named storms and 1 typhoon through today. This area normally averages 30 storms a year. The western Pacific is more strongly affected by El Nino than the Atlantic, and this may be an early sign of the impact that El Nino has on the Atlantic season. For a brief discussion of the affect of El Nino on hurricanes, please see my post from two weeks ago.

Note: Major Karma Points to the first person to correctly identify the hurricane shown at the top. This is going to be a common theme of posts for the foreseeable future. A small hurricane warning flag will be awarded to the individual with the most points at the conclusion of the hurricane season, provided that they have at least 12. This beautiful hurricane can be identified less so on its location, but rather by its shape and appearance. Double points to anybody who can give both its name, as well as its rather unusual classification at this point in its track.

Dpeezy and Wabisabi currently lead with 1 point apiece.

 

 

 

 

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Welcome to my first post looking to the week ahead in the Tropics and energy markets.

The Tropics

As is pretty typical for the first week of July, the tropics remain quiet. We have roughly a week and a half before the hurricane reason ramps up heading into August. The peak of the season is on September 12^th.

Figure 1: Plot of tropical cyclone frequency in storms/100 years

Interesting Fact: Since 1861 when records were first kept, no hurricane has made a US landfall on the 4^th of July. Mother Nature clearly knows how to show Uncle Sam the proper respect.

Today, there is nothing imminent brewing in the tropical Atlantic. An area of low pressure over the eastern Atlantic south of the Azores Islands has some associated convection on its east side, but is quickly heading towards its death over cooler waters. It has a minimal (<15%) chance to develop. The Gulf of Mexico is dominated by high pressure, with the resultant sinking air precluding any development. A weak tropical wave in the Caribbean is being torn part by strong westerly shear and is not a threat to develop.

Figure 2: Current satellite image of the Tropical Atlantic showing quiet conditions

None of the computer models predict any development in the upcoming week. Quiet is the operative word.

Cooling Demand

During the summer months, the supply of natural gas and oil is affected by hurricanes, while the demand is affected by continental temperature swings, namely cooling demand. As temperatures increase, cooling demand also increases, and vice-versa. Natural gas (and some oil) consumption is especially volatile given that it is used as the marginal fuel in electricity production. Coal and Nuclear powerplants, which together produce on average 68% of the nation’s electricity,  represent baseload generation. Plants using these fuels are very difficult to switch on and off and generally produce a constant quantity of power that satisfies the average day-to-day usage. However, when temperatures rise and fall, it is the natural gas plants that are quickly brought on- and off-line to meet the changing demand.

In the absence of hurricanes and other unusual shut-ins, it is useful to look at summertime temperatures to gauge natural gas supply and demand. The influence of temperature on natural gas demand can be seen in last week’s natural gas supply report, which accounted for the week ending June 26^nd, during which time the southern heatwave was in full swing. It reported an increase of only 70 BCF, the first time in 16 weeks that the net injection was below the five year average. This was a drop of 15 BCF from the previous week, a comparatively mild week. Anybody blaming such a drop on the falling Rig Count or a jump in industrial demand is an idiot. I will have a post dedicated to discussing the supply situation and what the hurricane season needs to do to prevent a potential disaster in October.

The most useful way to do analyze electricity demand is through cooling degree days (CDDs), which are the difference between the average daily temperature (High + Low divided by two) and 65. High CDDs obviously correlate to increased cooling demand.

So, what does the cooling demand look like for the upcoming week? I have written a kick-ass program that takes numerical computer model data and plots average CCDs for each county nationwide. Figure 3 below shows the projected Cooling Degree Days for the upcoming Sunday-Friday period for the lower 48.

Figure 3: Plot of predicted cooling degree days for the upcoming week

Figure 4 below compares this to the average for the first week of July:

Figure 4: Departure from average cooling degree days for the upcoming week showing cooler than average weather across the east and warmer than average across the Great Plains.

Based on this data, the entire east coast with the exception of Florida will be substantially below average. The Pacific Northwest will also be below average while the Southwest will be about normal. The only part of the nation that will be above average is the Central Great Plains, including Texas, Kansas, Nebraska, and Iowa through the western Ohio River Valley.

However, this is an improvement for most of the nation compared to last week which was substantially cooler after the previous week’s heatwave. Figure 5 below shows the predicted change from last week.

Figure 4: Change in Cooling Degree Days from last week showing a broad warmup in the Midwest, Great Plains, and Northeast.

Based on this data, most of the country will see increased cooling demand, compared to last week. The only areas that are predicted to be cooler from the week ago period are the Sacramento Valley of California and the Southeast, which were both still experiencing the last gasps of the heatwave last week. Some areas of the upper Midwest and south Texas may see increases of up to 30 CCD. Also, most of these increases will come late in the week as heat begins to build. The following week looks to be even warmer. It is encouraging to see a broad warm-up in the Northeast and upper Midwest, as these places have the highest population densities in the nation and are large electricity consumers. The Northeast in particular has been suffering a “year without a summer” thus far, with an area of low pressure parked offshore for much of June.

One must remember that the effect of this week’s temperatures will not be released until the NG supply report on July 9^th. This week’s report will give data for last week (for the week ending July 3^rd). Based on last week’s milder weather and this week’s warmer-but-still-mild temperatures, I expect we will see two pretty big numbers in the next two weeks. The five year average for the upcoming week is 90 BCF. Based on the meteorology, I tentatively project this week’s reported injection to be between 95-100 BCF and next week’s to be between 85-90 BCF. These large injections coupled with the quiet tropics may increase selling pressure on energy commodities this week and present attractive buying opportunities in the short term heading into the brunt of hurricane season. Right now, I am happy with my hedged position, LONG UNG and LONG ½ DTO (x2 short Oil ETF). I may look to slowly unwind my DTO position if Oil falls below $60 and NG falls below $3.50. Read CavemanForecaster’s great post on this pair trade.

Note: Major Karma Points to the first person to correctly identify the hurricane shown at the top. This is going to be a common theme of posts for the foreseeable future. A small hurricane warning flag will be awarded to the individual with the most points at the conclusion of the hurricane season, provided that they have at least 12. Dpeezy currently leads, 1-love.

Regards,

Citizen

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Welcome to Veritas5’s new blog, Dr. ‘Cane, Wishcasting Death to Oil Rigs Since 1924. I am finally shedding my erstwhile alias and embracing the PhD. Now fully qualified to do so, I will be discussing this year’s hurricane season, as well as other meteorological phenomena, and the investment opportunities they provide. Posts will include forecasting and perspective, stock picks and analysis, discussions of global warming and other climate issues, and the interplay between all three. Despite the title of the blog, you will find no wishcasting or cheerleading here, merely the application of hard meteorological logic and analysis as a means to bank coin. That being said, them rigs be going down.

Image: Somewhere in the Gulf of Mexico…

For a discussion of the 2009 Hurricane Outlook, please see my post last week in the PG.

The tropics remain quiet, as is normal for the first week of July. My first full post will be up Sunday morning. Until then, have a fantastic Fourth of July. According to the Crop Moisture Index (a short-term drought indicator) shown below, most areas can be pretty liberal with fireworks this year without worrying about burning down the neighborhood. Exceptions include south Texas and most of the southwest, which are under excessive to severe drought. Careful with the sparklers, bottle rockets, and homemade guided missiles in these areas.

Figure 1: Crop moisture index for last week.

Note: Major Karma points for the first person to correctly identify the hurricane shown at the top.

Regards,

John Mc

Best Pick: Long UNG, short ½ DTO.

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