After flirting with a major long-term technical level for months, natural gas futures look to once again be testing the possibility of another upside breakout. Record demand for gas for power consumption and warm temperatures have helped cultivate a rebound in prices after onshore gas in storage reached a new record back in April following multi-year lows reached back in March. Since then, prices have been on an upward tear, benefiting from the demand tailwinds combined with relatively stable production over time. However, despite the price action signaling the potential for further gains from current levels, there are still a few factors that could derail a sustained rally in prices. For one, storage levels remain significantly elevated relative to historical levels and furthermore, production could see a pickup. Even though winter months are likely to translate to stronger consumer demand, the future for prices remains fraught with risks.

Fundamentally Speaking

With the summer months now behind us, the time between now and winter in the continental United States usually marks the beginning of a period of weak demand for natural gas prices.  With lower demand for cooling, power generator demand will likely taper significantly ahead of winter heating needs. Furthermore, the net injections or additions to natural gas stockpiles have been relatively low the last several weeks, contributing the notion that the figure may rebound to more normal levels in the upcoming report set to be delivered by the EIA on Thursday. Higher injections indicate one of two things; either higher output and production or lower demand for natural gas. Current expectations are for an additional 60 billion cubic feet to be added to storage during last week. As of right now, stockpiles sit nearly 200 billion cubic feet higher versus levels reported a year ago, underlining the glut.

With supply continuing to outpace demand over the medium-term, the bullishness in prices might be a little premature without the advent of lower temperatures. Further derailing natural gas’s efforts to rebound is the ability of a certain portion of demand to switch between energy equivalents depending on what is cheapest. Although crude oil is not a traditional fuel used to heat homes during the winter, should prices continue to decline over time, it might see industrial demand switch to the cheaper source of fuel, which may be oil instead of gas. Natural gas production has fallen over time, helping to offset the supply glut to a degree. However, higher prices could very well be the same factor that keeps them under pressure, as higher prices invite back producers that abandoned projects due to low prices. The ease of restoring shuttered production may put a ceiling in prices over the longer-term.

Technically Speaking

Looking at natural gas price action, the bullish continuation that kicked off the summer months has persisted, with the commodity looking to break higher once more. The key resistance level to keep an eye on remains $3.000 per MMBtu after thwarting each attempt to break higher to date. At present, though, natural gas is on the verge of another breakout, thanks to the emergence of a head and shoulders bullish pattern. After forming the left shoulder and head, the right shoulder has more or less completed itself, with the neckline at $2.910 formed resistance against a breakout. A candlestick close above this level would be considered a breakout, especially if accompanied by higher momentum and trading volumes which would serve as confirmation. A failure at this level or break back below the shoulder line at $2.650 would pave the way for a run towards support at $2.530.

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Aside from the bullishness of the head and shoulders pattern is the supportiveness of both the 50 and 200-day moving averages. After a bullish crossover that could be viewed as a golden cross transpired back in June, the stage is set for a longer-term bullish run to the upside that will be accompanied by significant momentum. At present, both moving averages are acting as support against any prolonged downturn in prices. Also relevant is the breakout from the former downward trending equidistant channel formation. After breaking out, the upper channel line was once again tested but held up against a sustained downward run in natural gas prices, evidence of the strength of the latest rally. With these factors in play, the case for further downside is relatively null without a break of support at $2.530.

Looking Ahead

The major catalysts for any further tests on the upside for natural gas is storage reports released every Thursday from the EIA.A smaller than anticipated increase could be a precursor to upward pricing pressures in natural gas, however, any disappointment may result in a deep retreat for prices, especially as seasonal factors see demand dip. Additionally, the switchable nature of natural gas and oil in some cases may mean a further decline in oil prices leads to worsening demand for natural gas as price sensitive sources of demand pick whatever is cheapest. With winter heating needs still months away, the primary driver meantime will be the degree by which supply outpaces demand. Should the disparity shrink significantly, the current oil price rally may continue. However, without a catalyst, the rally could find itself taking a breather and experiencing a deeper correction after the rally from March lows.