Following a 36-cent rise Monday through Thursday last week, the natural gas futures market braced for a profit-taking sell-off Friday. As it turns out, the market was half right. Locals and commercial traders liquidated their longs ahead of the weekend, but what the market did not bank on was continued short-covering by the non-commercial segment of the market, which soaked up enough selling to limit the day’s losses. September finished at $3.487, down 2.8 cents on the day and roughly in the middle of its $3.44-52 trading range.

“The natural gas market calmed down on Friday, with trade largely limited to light book squaring ahead of the weekend,” wrote Tim Evans in a daily note to customers. “For locals, this meant selling out short-term longs, while fund managers continue to cover shorts.” Evans may have a point. According to the latest data from the Commodity Futures Trading Commission, the non-commercial segment of the market reduced their net short holdings by more than 7,000 positions for the week ending Aug. 20. At an even 19,000 net short, these speculative accounts hold their smallest net short tally since July 9.

In addition to short-covering and position rolling by funds, Friday’s strength can be attributed to cash market prices, which notched double-digit gains to converge with September futures. But looking ahead at milder weather forecasts, those gains may be short-lived. According to UBS Warburg analyst Ronald Barone, the industry “may have just experienced its last true bout of extreme temperatures for the season.” Barone’s latest NatGas Insight pointed out that national cooling degree-day temperatures were 18% warmer than normal and 23% warmer than last year for the week ending Aug. 17. To date, temperatures are averaging 11% warmer than normal and 3% warmer than last year.

According to the National Weather Service’s latest six-to 10-day outlook, the eastern two-thirds of the country should experience normal to below normal readings, while temperatures are still expected to average mostly above normal for the remaining western third. Looking on down the road, the NWS September outlook is calling for temperatures above normal across the western third, with normal conditions expected in the eastern two-thirds of the Lower 48.

However, traders will be quick to tell you that the weather is only half the fundamental equation. Also key to any fundamental analysis is supply, and market-watchers will be eager to see what is revealed when the Energy Information Administration releases fresh storage data Thursday morning. Kyle Cooper of Salomon Smith Barney in New York calls for an injection in the low- to mid-50s Bcf range, which, if realized, would fall short of last year’s comparable 74 Bcf build. And although prices have shot higher in each of the last three Thursday sessions, Evans is dubious of the current price level. “Storage withdrawals will continue to run less than last year, which would be supportive if the market were fairly valued now. However, with storage 231 Bcf above last year’s level and prices 25% above where they were on this date last year and double where they fell to last September, we can’t call them fairly valued.”

Jay Levine of New Hampshire-based Advest Inc. agrees that prices are a little high, but points to technical factors for justification. “Welcome to the world of the short squeeze,” he quipped in his best rendition of a carnival barker. “Just when you think it can’t go any higher, it does. The market feeds off of itself, and it could extend higher [this] week, but I’d give September only a 10% chance of settling above $3.75 and only a 5% chance of settling above $4.00.

“You’ve got resistance at $3.52 and a double top at $3.58. The only question that needs to be answered is whether we see lower prices on options expiration Tuesday or on futures expiration Wednesday.”

Although he ultimately looks for prices to reach the $4.50-80 level, Levine believes the short-term risk is to the downside. Accordingly, he suggests that producers might want to take a look at selling October at the money and out of the money calls and using the proceeds to buy out of the money puts. His downside target begins in the low $3.20s.

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