Why natural gas prices have rebounded from spring 2012 lows
Natural gas prices reached historical lows in 2Q12 at roughly ~$2.00/mmbtu (or millions of British thermal units) as can be seen in the graph above.
Primarily, the price drop was due to the development of US shale resources, which have produced natural gas prolifically and have resulted in huge increases in supply as seen in the second graph below.
Compounding this effect was an abnormally warm winter, with heating degree days1 ~21% below the five year average, resulting in less demand for natural gas. The third graph below shows the heating degrees over the past five years and one can see that last fall and winter (October 2011 through March 2011) was much warmer than normal. The combination of increased supply and decreased demand resulted in record low natural gas prices, and historically high natural gas inventories.
Low natural gas prices have the effect of putting negative pressure on upstream energy companies. This is especially true for independents (companies involved solely in the production of hydrocarbons and not the refining and marketing of them) with a large portion of production coming from natural gas such as Chesapeake Energy (CHK), Range Resources (RRC), Southwestern Energy (SWN), and Quicksilver Resources (KWK). Low natural gas prices also negatively affect the value of the US Natural Gas Fund (UNG) an ETF designed to track US natural gas prices.
Since 2Q12, natural gas prices have rebounded and the commodity currently trades at ~$3.60/mmbtu. Natural gas prices have been supported in part by increased demand, as some power generators took advantage of cheap prices and chose to use natural gas as a fuel rather than coal, which was relatively more expensive. In this industry, this is called coal-to-gas switching.
Additionally, a hot summer in the US last year caused demand for natural gas to increase as power was required to run air conditioning units. Lastly, because low gas prices have caused some natural gas drilling to be economically unattractive, some gas producers have curtailed drilling which has restrained the natural gas supply.
Though natural gas prices have been largely bullish over the past nine months, in the medium term weather could pose a risk if a milder than normal winter is realized. Additionally, the coal-to-gas switching trend by power producers could reverse somewhat as natural gas prices rise and gas becomes more expensive relative to coal.
An extended rally in natural gas prices could be a positive catalyst for the valuation of natural gas producers such as the ones mentioned above (CHK, RRC, SWN, and KWK) and the UNG ETF.
- Heating degree days are a measurement used to reflect the demand for energy needed to heat a building. Less heating degrees are a reflection of warmer weather and vice versa. ↩
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