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Futures Surge 8.5% Higher on Near-term Cold

Following a couple of back-and-forth trading sessions, prompt-month natural gas futures on Wednesday exploded 8.5% higher as colder than normal temperatures took hold in a number of regions around the country. After topping out at $7.750 on the day, November futures -- which expire Friday -- settled at $7.693, up 60.2 cents on the day.

The winter months also recorded significant gains on the day with December natural gas jumping 39.2 cents to $8.328, while the January and February contracts increased by 37.5 cents and 37 cents, respectively, to finish the regular session at $8.701 and $8.731.

Taking stock of the recent move, one prominent analyst advised the bulls to take their recent gains and get out before a warming patch in the weather hits.

"The natural gas market held where it needed to in its Friday-Monday pullback and is now swinging higher again, taking advantage of nearby cold to pressure bears and consumers alike while there is still an opportunity," said Tim Evans, an analyst with Citigroup in New York. "In effect, the bulls are making hay while the sun shines."

He added that bulls should "ring the cash register" because he does not see these weather conditions holding indefinitely. "Already, some of the projections for the 11-15 day period show both more confident indications of warmer than normal temperatures in the West, less confidence for residual coolness in the East."

Looking at the big picture in natural gas futures, Evans said he sees the market pressing higher as long as it is supported by above average heating demand, but coming under heavy selling pressure once a warming trend comes along to undercut the cash market. "In short, we view the upside as limited and uncertain, the downside more open and inevitable."

Evans said his team recommends working a $7.95 sell stop as the entry to a short position in January natural gas. He added that a protective buy stop at $8.45 is suggested to limit the initial risk on the position once an entry is made.

Traders are somewhat skeptical of recent weather forecasts. "WSI came out with a forecast of a cold December and a warm rest of the winter," noted a Denver gas trader and marketer. He said that at the end of October and November every year it's "almost like clockwork" that traders will try to run the market higher on reports of a cold winter. They will be looking for a selling opportunity once the hype of a cold winter dissipates, he said.

"We will be looking hard at the March-April spread as a selling opportunity," he added. "If we see that spread at $1.00 or $1.50, we would be selling that spread [selling March and buying April]." He added that if the market stages a nice rally in November, "we would be looking at selling it." The March-April spread settled Wednesday at 60 cents.

The trader pointed out that the spread also had risk management characteristics. "You could almost use that spread as a hedge for producers for it is driven by the direction of the market," he said. "What we like about it is that even if prices are flat, it tends to make money on a normal seasonal progression. We have seen in the past that even if prices advance, the spread will contract. It could definitely be used as a hedge for a producer on the downside."

Others also see the market as a short-term weather-driven phenomenon. "Although we don't anticipate major upside risk, it does appear that these cold patterns will need to be extracted from the forecasts before price declines are capable of being sustained," said Jim Ritterbusch of Ritterbusch and Associates.

Ritterbusch is cautious and is maintaining a bearish trading posture with the expectation of the December contract falling to the $7.250 area. Like the Denver trader, he also favors the idea of spread trading by selling nearby months at the expense of buying more distant contracts. "Back spreads, such as long February or March...short December are also favored," he said.

Hype or not, cooler weather remains in the forecast. AccuWeather predicts a Thursday high of 48 in Chicago rising to 55 by Monday. The normal high this time of year in the Windy City is 60. New York City's Thursday high of 54 is expected to rise to 56 by Monday. The normal high in New York is 61, the forecaster said.

Meanwhile, the attention of traders and analysts now turns to Thursday morning's natural gas storage report for the week ended Oct. 20. Citigroup's Evans said he sees the Energy Information Administration (EIA) revealing a build in the 30-40 Bcf range, which "shouldn't warrant any material potential for an emotional shock" to the market in either direction. "With the storage total poised to break above its 1990 all-time record high, we think the market may focus more on the record level of the total inventory overhang and less on the usual year-on-five-year average comparison benchmark."

With storage sitting at 3,442 Bcf as of Oct. 13, stocks are fast approaching the all-time record of 3,472 Bcf, which was posted at the end of November 1990. According to the EIA, the country injected a significant 77 Bcf into underground storage last year for the week while the five-year average sits at a less impressive 49 Bcf build.

A Reuters survey of 24 industry players is calling for an average build of 31 Bcf, while the ICAP storage options auction on Wednesday indicated a 24 Bcf injection.

Golden, CO-based Bentek Energy projects a storage injection of 27 Bcf, resulting in 3,469 Bcf of gas in storage. This level in storage would be 10.3% above the five-year average and 6.7% over the five-year high.

Bentek expects to see a 16 Bcf injection in the East, while 6 Bcf will be injected in the Producing region and 5 Bcf will be put into the West region. "This outlook is directionally in sync with the storage injection number implied by our Supply/Demand Report Analysis," Bentek said. "Versus last week, demand was up by 19 Bcf, production up by 2 Bcf, imports down 3 Bcf and LNG sendout up 1 Bcf. Last week's EIA was 53 Bcf, so an injection of 34 Bcf is indicated by this estimate approach (53-19+2+1=34 Bcf). Given the uncertainties this week, we consider this 34 Bcf in the ballpark of our 27 Bcf outlook."

Bentek's inventory estimates now show eight U.S. storage facilities at or above 100% and 11 other facilities at 95% to 99% of capacity.

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