2015 El Nino and the U.S. Energy Markets

Andy Waldock |

The El Nino event of 2015 is expected to become the strongest on record. Considering the impact this event is supposed to have on our southern states, it's time to review what has happened in the past as well as what may be coming. We'll let the National Oceanic and Atmospheric Administration (NOAA), finish our intro. From NOAA's analysis of the 1997 event. "The winter of 1997-1998 was marked by a record breaking El Nino event and unusual extremes in parts of the country. Overall, the winter (December 1997- February 1998) was the second warmest and seventh wettest since 1895. Severe weather events included flooding in the southeast, an ice storm in the northeast, flooding in California, and tornadoes in Florida. The winter was dominated by an El Niño-influenced weather pattern, with wetter than normal conditions across much of the southern third of the country and warmer than normal conditions across much of the northern two-thirds of the country. "

Current expectations hover around 95% for this year's event to continue through spring of 2016 before returning to normal. El Nino's impact on the energy markets must be looked at through a domestic lens due to the current physical and legal issues affecting U.S. energy exports. The primary sources for U.S. heating are natural gas and heating oil. Natural gas can be shipped in liquefied form (LNG) however, global infrastructure being developed is still in its infancy. Eventually, liquefied natural gas will flow from ports in the Gulf as well as California to be shipped around the world. Until then, the natural gas harvesting as a byproduct of fracking along with the direct drilling for natural gas will continue to produce a domestic glut. The second issue to address are the legal restrictions dating back to the late 1970's that prohibit the direct exportation of crude oil. Heating oil and other refined crude oil products are legal for direct exportation but raw crude oil is not. Once again, this exacerbates the current glut of energy production raw materials in the U.S.

So, what does this year's El Nino event look like according to the experts? I've read tables and reams of information and the following charts from climate.gov, within the NOAA site, are truly worth 1,000 words.

The expected changes and probabilities of precipitation variation as a result of 2015 El Nino across the United States.
The expected changes and probabilities of precipitation variation as a result of 2015 El Nino across the United States.
The expected temperature variations for the coming winter due to the effects of 2015's El Nino effect.
The expected temperature variations for the coming winter due to the effects of 2015's El Nino effect.

Finally, one more graphic to dispel any energy flow disruptions due to hurricane season.

Weather.com has researched the typical hurricane season as compared to El Nino hurricane season and found, once again, the hype is wors than the reality as the U.S. hurricane season far more mild and actually ends earlier than normal.
Weather.com has researched the typical hurricane season as compared to an El Nino hurricane season and found, once again, the hype is worse than the reality as the U.S. hurricane season is far more mild and actually ends earlier than normal.

As you can see, temperatures are expected to be far more mild than typical in the states that are the most sensitive to the vagaries of winter weather in the United States. Furthermore, these charts should dispel much of the fear that grips the uneducated news watchers and supermarket tabloid readers preparing for El Nino. Don't let fear and ignorance put your hard earned Dollars at risk based on the sensationalism required to sell advertising. The following natural gas and heating oil charts clearly make the case for, "Buy the rumor. Sell the fact."

The real issue at stake here is, "How do we profit from this set of assumptions?" Hype followers are rookie traders. Very few rookie traders ever make it to veteran status. Our research has shown time and again that the small speculative traders are frequently wrong. Worse yet, they tend to have their biggest positions on at the absolute worst possible moments. They're so bad that we've actually generated successful mechanical programs based on simply doing the opposite when their positions hit extreme levels.

Unfortunately, small speculator behavior is too erratic to be relied upon as a sole source of decision making. Therefore, rather than simply following those who are typically wrong, our work focuses on following the traders that are usually correct; the commercial traders. These are the drillers and processors that make up the core of this industry. They know when prices are over or, under valued and take action accordingly. This is also why the commercial traders tend to have their largest positions on at the most opportune moments. The heating oil and natural gas charts below focus on the price action from January of 1996 through December of 1998. This covers where the markets were trading pre-1997 El Nino as well as their reactions to the changing weather patterns and finally, how the markets fared coming out the other side of what had been the most significant El Nino event on record.

In spite of the hype surrounding El Nino, the reality is lower energy prices in the United States. This is characterized by commercial heating oil processors selling their forward production on every attempted rally.
In spite of the hype surrounding El Nino, the reality is lower energy prices in the United States. This is characterized by commercial heating oil processors selling their forward production on every attempted rally.

Commercial processors are well aware of their input costs, run rates and production potential. As such, they based their trades on data rather than hype. This put them on the sell side as they attempted to lock in profitable forward production rates.

The heating oil situation is pretty simple as it's primarily used for heating. Natural gas on the other hand is used for electricity generation which runs air conditioners as well. Furthermore, in 1997 the natural gas market did not have the elasticity it does in today's environment. Alternative energy sources, green building techniques and the development of LNG shipping methods have added more and stronger variables than were in play 18 years ago. Therefore, we've indicated commercial buying and selling as both sides of this market were traded heavily by its drillers and distributors. This is the basis for our work at CotSignals.

The natural gas market is dominated by the distributors and drillers on the buy and sell sides, respectively.
The natural gas market is dominated by the distributors and drillers on the buy and sell sides, respectively.

Finally, I'd like to close with two more charts that illustrate the how the changing landscape of the energy industry could conspire with a publicly over-hyped event to send energy prices to new lows into the end of the year. The following seasonal charts provided by Moore Research (MRCI.com) illustrate the evolution of an energy independent United States. Note that the three line graphs show the 5-year, 15-year and life of contract seasonal patterns for both heating oil and natural gas for their December contract expirations. In both of these charts, the 5-year pattern is cheaper than the 15-year and the life of contract patterns.

The december heating oil future's pattern has shown decreasing strength as domestic production has skyrocketed over the last 10 years.
The December heating oil future's pattern has shown decreasing strength as domestic production has skyrocketed over the last 10 years.
The natural gas market has shown a similar weakening in its seasonal pattern due to increased U.S. production.
The December natural gas market has shown a similar weakening in its seasonal pattern due to increased U.S. production.

El Nino is a warming event for the United States. It stands to reason then that this year's potentially record breaking event should lead to a warmer winter in our northern states. This would lead to lower domestic energy demands. Lower end user demand would also reinforce the recently weakening seasonal patterns. Given that some poor souls have added investment capital in these markets, there could be a significant flush lower as the energy markets attempt to make a meaningful low based on the new U.S. Paradigm.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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