Natural Gas Analysis for the Week of February 6, 2012

March Natural Gas “followed-through” to the upside last week after the previous week’s closing price reversal bottom if you consider a .0060 move through the previous high a follow-through rally. The move nonetheless moved the swing indicator and helped form a new main bottom at 2.2890.

Last week I warned that the fundamentals were stacked against the market so that while it was possible a major bottom was beginning to be formed, I pointed out that it would take time to build the support base necessary to ignite the start of a major rally. The conclusion I reached was that the market was poised for a relief rally due to oversold conditions and that at best, the upcoming rally would last 2 to 3 weeks and equal at least 50 percent of the last rally.

Although March Natural Gas closed lower for the week, it did hold the important test of the main bottom at 2.2890 and it did follow-through to the upside (albeit small). The existence of these two positive factors gives the market an upside bias going into this week’s action.

Don’t get me wrong. I am not trying to paint a rosy picture of the market, I am merely pointing out a few of the key developments from last week that are slightly different from the bearish action of the previous weeks. Markets, after all, have to go through a transition period when sentiment shifts from down to up and it is possible that this sentiment shift is taking place now.

Of course, taking out the bottom at 2.2890 will negate the reversal and resume the down trend, but at this time I feel that it is more important for short-traders to protect their hard-earned profits because it doesn’t look like natural gas has much more room to the downside. This will be especially true if the Obama administration follows-through on its promise to develop the U.S. natural gas industry.  Long-term traders should keep an eye on the deferred contracts (January 2013, for example) to see if there is a decoupling of the chart pattern from the nearby market. This often serves as an early warning that change is on the horizon.

The recent bottom was formed when President Obama mentioned in his State of the Union address the possibility of developing a plan for U.S. natural gas usage. This news brought smiles to the face of producers as well as bringing fear to the hearts of bearish traders. Short-term traders seemed to be looking for an excuse to take profits while longer-term bottom pickers may be sensing they are giving the opportunity to get in on the ground floor.

Despite the president’s positive speech, the driving factor still remains the supply and demand situation. Demand has been awful because of the mild winter. In the meantime, the amount of natural gas in storage has continued to grow as producers have become more proficient at ‘fracking’, a technique used by producers to remove natural gas from the ground. Improvements in technology and drilling techniques have made producers extremely proficient using this method of extraction.

High priced crude oil has also contributed to natural gas’s bearish supply and demand situation. With crude oil hovering near the $100 per barrel price level, oil producers have maintained a high number of drilling rigs. During the initial stages of drilling for crude, natural gas has been harvested and sold. Since this gas is being produced virtually cost-free, any money these producers receive is basically all profit. Until the number of producing rigs drop substantially it is going to be hard for prices to rise. Traders should watch the rig count trends to see if this number is dropping. This could help the market build a support base.

Another fundamental event that traders should watch is the amount of natural gas in storage. With winter coming to an end, it is possible that natural gas in storage will end the season at it highest level in history. This means that under normal conditions, natural gas could reach full storage capacity by May.

Chesapeake Energy and ConocoPhillips are considering limiting production. If this trend continues then it is possible that producers will be able to gain control of the supply side of the equation. This little bit of news could be enough to spark a rally. Last week, supply fell by more than expected. This is another sign that the market could be turning the corner. Traders should wait to see if there is follow-through to the upside this week. If it doesn’t happen or if the recent bottom is breached then look for the sideways-to-lower trading to continue.

Factors Affecting Natural Gas This Week:

Weather:  We’ve hit the half-way point between winter and spring and temperatures continue to remain above average. This is not helping the supply/demand situation. The last hope for traders will be a late season cold-snap like Europe is experiencing.

Supply and Demand:  Supply fell more than expected last week. This came as a surprise and helped boost prices. Production has to be reined in or natural gas in storage will reach full capacity. The fact that the rig count is declining and that two major producers are curtailing activity is a major development. Others have to join in to make this strategy effective.

Oversold Conditions:  The natural gas futures market is oversold according to several methods of measurement, but the commitment of traders still favors the downside. Traders should watch this indicator to see if the number of shorts in the market is shrinking. This will be the first sign that the selling pressure is finally subsiding.

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