With the Fly once again talking about impending Deacons of Death, I thought it might be a good idea to do a meteorological post since hurricane season officially starts today. This being my first post, a little bit about myself: I am a third-year atmospheric sciences major at Harvard University, who is also big into trading. I do swingtrading and the occasional day trade. I use weather patterns to frame the basis of a lot of my swing trades, playing the natural gas storage report game during the winter and hurricanes, both long and short, during the summer. Note: This post is pretty much focused on the upcoming hurricane season. If you are looking for investing ideas, this post will not really have any. If Danny can post about Full Complexities, I figured talking about the weather would be okay. Subsequent posts will detail my investing strategies and stock picks.

For those who missed it, we had our first storm of the year yesterday. Tropical Storm Arthur formed, hit Mexico’s Yucatan peninsula as a 40 mph tropical storm, and is now dying insland, all in the space of about 12 hours. It should not have any effect on NG prices come Monday. While having a May tropical cyclone is somewhat unusual, it does not correlate with a more active hurricane season.

Tropical Storm Arthur

There are three main macro-scale factors that influence the number and strength of storms during the upcoming season. The first, and most obvious, is ocean temperature. A hurricane is a heat engine and derives its fuel from the ocean. A hurricane cannot sustain itself below 26C, or 79F. However, an accurate determination of available “fuel” for a storm goes beyond simple “sea surface temperature” since SST only measures the temperature on the very top layer of the ocean and a potent storm quickly mixes colder water up from lower depths. A more useful measurement is “Tropical Cyclone Heat Potential,” which is a measure of total heat energy available to a storm, which takes into account the ocean temperature at depth.

When making any prediction about hurricane strength and number, it is best to turn to the extraordinary hurricane season of 2005 for comparison. That season produced a record 27 named storms, including Dennis, Katrina, Rita, and Wilma. While the sea surface temperatures this season are similar to 2005, the Tropical Cyclone Heat Potential is significantly lower than than 2005, particularly in the Caribbean, where NG-influencing storms usually power up.

May 30, 2008

May 30, 2005

Heat potential is a better predictor of storm strength rather than storm number. By July and August, all of the tropical Atlantic will be warm enough to support storms. However, it is the areas of high Heat Potential (Generally greater than 80) that allow for Category 4 and 5 storms to develop. This all being said, ocean temperatures are still above their long term averages (as they have been for the better part of a decade) so just because I don’t think the 2008 season will be like 2005, doesn’t mean it won’t be active.

The second factor is wind shear. Wind shear is the changing direction of wind direction with height and acts to tear storms apart, since a hurricane relies on its cloud layers being well-stacked. Wind shear, unlike heat potential, is a better predictor of the number of storms likely to develop during the season. It was due to high wind sheer that we had a more moderate-than-expected hurricane season last year (only 15 storms), despite having a far above average 2 category 5 storms. Current wind shear is hardly indicative of future shear, so I won’t bother with comparisons to 2005 and other seasons. NOAA makes average wind shear predictions out about 5 months, and based on their projection, wind sheer should be slightly below normal during the peak of hurricane season, which suggests a more favorable environment for storms to develop.

The last factor is the strength of the El Nino-Southern Oscillation (ENSO). A positive ENSO (warming of the equatorial east pacific) results in El Nino while a negative ENSO (cooling) results in La Nina. While there is still much debate as to ENSO’s effect on Atlantic hurricanes, the general consensus is that El Nino reduces cyclone number while La Nina increases it. Currently, we are in a weak La Nina, which is forecast to persist or gradually weaken to neutral over the summer. Based on current numbers, the 2008 temperature profile is most similar, in recent years, to 1999-2001, which had 13, 15, and 15 storms per season, respectively, or slightly above average. For reference, 2005 was neutral, or “la nada.”

One more point. If you see a forecast claiming there is an 80% chance of a hurricane hitting Texas or Louisiana this season, don’t rush out and load up on NG thinking you are ahead of the game. Steering patterns can be predicted at maximum a week and a half in advance, so any prediction claiming landfalls months out is a load of BS. Pre-season tracks are little more than dice rolls.

Based on this data, I expect a more active than usual storm season. Storms follow roughly bi-decadeal cycles of activity, with the 1950s and 1960s being active, the 1970s and 1980s being quiet, and a new active period beginning in 1995. Since we are currently in a long-term period of heightened activity, the odds favor more storms, despite only modestly favorable conditions. I expect 16 named storms (through Paloma), which is above the average of 10-11, and slightly above Dr. Bill Gray’s “official” forecast of 15. However, due to lower heat potential of the Caribbean and Gulf, I expect only 7 hurricanes and 3 “Major” (category 3 or higher) storms, compared to Gray’s forecast of 8 and 4, respectively. The average is 6 and 2.

Because it is still early, and with energy remaining near record highs, I am not going to be buying any natural gas stocks yet. When I do, my favorites are GLF, OMNI, NGS, as well as UNG. For those who do like to speculate, other market effects notwithstanding, there is often a run-up in energy-related stocks in late May through June in anticipation of an active hurricane season, followed by a decline in July and early August as no hurricanes have developed yet. My next post will be much more market-oriented and will include case studies using particular storms, and other meteorological events, on how to invest and when to sell out ahead of an impending storm.