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 12th.
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 4th 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 26nd, 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 9th. This week’s report will give data for last week (for the week ending July 3rd). 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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could it be Katrina?
andrew?
make that floyd
final answer
No idea, really. Magic 8 Ball says: Frances.
I can’t wait for that freaking ‘cooling’ that we are supposed to have here in the Central Valley (Sacramento). Been dying in this constant 100+ heat (for the last 2+ weeks).
Hugo.
___
Gustav
Great stuff Dr. ‘Cane.
By the way, on that pair trade, I bought the DTO side of it mid last week but am holding off on the long UNG side since UNG was sliding down fast when I bought the DTO. As soon as UNG stops dropping, I will probably pick it up and complete the pair trade.
Even a sniff of a tropical storm at this point and UNG has a quick 4 dollars up. I am buying this moring as I agree we are just starting cane of death season.
Floyd it is. Wabisabi picks up a point.
Gapping, I agree. I increased my position by 10% this morning.
I’m still waitin on UNG and enjoying my DTO position. I still think UNG may have a continued ugly shakeout here that would be an even better opportunity.
Caveman, certainly. However, I’ve always believed that gas under $3.50 is a good deal. Sure it may go lower, but I don’t think it can stay under $3.50 for long without production getting cut to support prices. I think it has a favorable risk-reward. Besides, I did not purchase an aggressive position, only 10%, at 12.50.
Agreed. I think we are certainly near a fundamental support price point.
Don’t know about UNG, but I have some CHK calls that I got last week when it looked like it might break above $20 (based on my ‘technical’ signals).
That obviously has worked out terribly. Fortunately it was just a tiny position.
Where is the wrath of mother nature, dammit?!
DOes UNG acutally buy NG? or does it just follow the price of NG contracts? If it just follows the price of NG and doesn’t actually participate in buying NG, isn’t it then possible to sell NG to drop it’s price and then profit hugely by being short UNG? That is assuming that it would cost alot less money to bring NG down then the profits you would make shorting UNG.
How much money does it actually take to bring NG down — say 5 cents?
If it only costs you 2 million to bring NG down 5 cents, then you could short 10 million short UNG and make a killing. I am making alot of assumptions – don’t know exactly the money involved in NG contracts.
Sergei,
UNG invests fully in the front month contract of NG. It then rolls over into the next month’s contracts a week before the front month expires. So right now, the UNG fund owns solely AUG ’09 calls. So, I don’t think what you’re saying would work. Most ETFs work in this way. The problem with this form of management is that shareholders don’t profit from the rollover. This is especially unfortunate right now due to the strong contango in the NG market. Say today is the rollover date and the front month contract is 3.48 and the sept ’09 calls are 3.62. The contracts are now 14 cents higher, but the value of the UNG fund is unchanged. Options isn’t really my forte, so perhaps somebody could explain this better. There is a 12 month Oil fund that invests in a basket of contracts for the leading 12 months. This helps minimize rollover “losses.” Apparently, there is a similar fund for NG in the works.
That is not to say there is no price manipulation going on. The 20x increase in volume in UNG over the past 4 months really makes one wonder what’s going on.
Seems like too many people are in UNG. Market likes to make the most people lose the most money.
That is often the case. However, look at a 1 year chart of USO. It too experienced a 5x volume increase as it bottomed in Feb and proceeded to rally 75%. That being said, until supplies start to drop or we get some ‘canes, I don’t want to be net long NG. I like my DTO hedge…a lot (look at the volume on that one as well).
Well the one I look at it, it is likely that by the time you see supplies start to drop, it will already be too late to get in, or you will miss most of the move.
I remember how everyone had a $150 price target on oil back in the day, and it went to $148 or whatever it was. Someone waiting with a sell order at $150 is still waiting to get out.