February natural gas continued its descent along a pair of downtrending Gann angles at 2.958 and 2.850 this week. By the end of the week, however, the market had reversed course, forming a closing price reversal bottom and setting up the possibility of a near-term short-covering rally.
Typically, a closing price reversal occurs when there is a dramatic shift in investor sentiment caused by an important change in the fundamentals. In this case, oversold trading conditions were solely responsible for the turnaround.
Traders should keep in mind that a closing price reversal only signals a temporary bottom and not a change in trend. Based on the short-term range of 3.741 to 2.936, conditions are ripe for a 2 to 3 week reversal back to 50 to 61.8 percent of this range, or 3.339 to 3.433 respectively. If this area is reached over the short-run then traders should look for the selling pressure to resume especially since the fundamentals remain bearish.
Besides the retracement zone, a downtrending Gann angle from the 3.741 top comes in at 3.261. This helps to form solid resistance between 3.261 and 3.433. In addition, the main trend will remain down unless the last main top at 3.41 is violated and this event seems very unlikely this week.
Fundamentally, natural gas inventories continue to climb. The mild winter has caused inventories to fall less than analysts had predicted. Continued injections have also played a major role in the bulging inventories. There is a problem developing that could have a major impact on natural gas prices in a few months.
The huge inventory picture is leading some analysts to predict that the U.S. could run out of natural gas storage space later this year.
Last week the U.S. reported for the week-ending December 30 that natural gas held in storage by companies fell just 76 billion cubic feet, to 3.5 trillion cubic feet. The Department of Energy also said that the five-year average for the week is typically a decline of 106 billion cubic feet. So although storage fell, it was far less than what normally occurs at this time of the year.
Also hitting the market was the news that inventories are their highest ever for this time of the year and about 12% above levels from one-year ago. The key number, however, was found in the total capacity. This figure reached 4.1 trillion cubic feet or about 85% full storage capacity.
The unusually warm winter is to blame for some of the decline in prices as demand from residential and commercial units has waned. But this isn’t the whole supply and demand story. Natural gas producers and oil drillers have shown no sign of letting up on their shale-gas operations. Even with prices at extremely low levels, the fresh supply keeps coming in.
If the situation continues and winter demand remains low along with new injections of supply then the market could be facing an inventory above 2 trillion cubic feet for the first time in history. By spring, natural gas storage could be at a level that could cause it to reach full capacity once inventories start increasing later in the year when demand for heat drops substantially.
It seems the only event that could prevent this from occurring is below average temperatures over a prolonged period of time. This should spur additional demand, helping it to overcome the weekly injections of supply. The weather is a crapshoot, however, so this means it is going to take a slowdown in the shale-gas drilling to put a real dent in inventory.
The thought of overcapacity is still far off so traders are likely to focus on the weather this week. A shift in temperatures should help drive up demand. Last week’s technical reversal to the upside may have been driven by the belief in the 10-day weather forecast which calls for below average temperatures. Traders should watch for a move through 3.123 to confirm the reversal formation. If this occurs with some conviction then watch for the start of a 2 to 3 week rally back to 3.339 to 3.433.
Factors Affecting Natural Gas This Week:
Weather: The 10-day forecast is bullish for prices. Below average temperatures are expected to drive up demand.
Supply and Demand: Even if demand increases, the question remains will demand outstrip production. In order to truly cause a decrease in inventory, shale-gas producers must cut-back on their aggressive drilling operations. Traders should continue to watch the active rig number. If this number falls below 800 then production may begin to fall below demand.
Oversold Conditions: Yes, the market is oversold but something has to take place to drive the short-traders out of the market. Last week’s closing price reversal bottom on the weekly chart could be the first sign of this turnaround. A prolonged drop in temperatures may be the second part of the
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