Milder temps last week put downward pressure on nat gas demand

2013.06.10 - CDDEnlarge Graph

  • Electricity generation uses a great deal of natural gas, and, therefore, demand for nat gas increases in Summer months when air conditioning is in heavy usage.
  • All else equal, higher natural gas demand results in higher natural gas prices, which increases the revenues and earnings of natural gas producers.
  • Last week, temperatures were milder than normal which is a negative catalyst for natural gas demand and, therefore, prices.

Natural gas is a major fuel used in electricity generation and, therefore, demand increases in the Summer when more electricity is used for air conditioning; hotter than normal weather can increase natural gas usage and consequently natural gas prices. For example, during the Summer of 2012, record hot temperatures were experienced in much of the U.S. Cooling degree days from the week ended May 5th through the week ended September 29th totaled 1,311 compared to an average of 1,079. During that period, natural gas prices rallied from ~$2.30/MMBtu to ~$3.30/MMBtu, partially due to the unusually hot summer. Natural gas price movements especially affect the earnings of major domestic natural gas producers, such as Chesapeake Energy (CHK), Range Resources (RRC), Quicksilver Resources (KWK), and Southwestern Energy (SWN). Additionally, many of these companies are part of the energy ETFs, such as the Vanguard Energy ETF (VDE).

For the week ending June 8th, cooling degree days for the U.S. totaled 37 versus the normal figure for corresponding weeks past of 39. Cooling degree days (CDD) are a measure of how much warmer than room temperature the weather is, and the greater the CDD figure, the hotter it is. This week’s CDD figure was slightly lower than normal, meaning weather was cooler than normal which implies less natural gas demand and, therefore, lower natural gas prices. On June 7th, natural gas prices finished down at $3.83/MMBtu compared to $3.98/MMBtu on May 31st, with some of the bearishness due to higher than expected builds in natural gas inventories, and continued milder weather could result in more high inventory builds (see Higher than expected increase in nat gas inventories sends prices lower).

Theoretically, lower demand translates into lower natural gas prices, which affects the earnings and valuations of natural gas weighted producers. The below graph displays natural gas prices over time versus the stock prices of CHK and KWK, two producers with production currently weighted towards natural gas. Over the past few years, the equity prices of these companies have trended with natural gas prices.

2013.06.11 - Nat Gas vs CHK vs KWKEnlarge Graph

Investors with holdings in natural gas weighted producers (such as CHK, KWK, RRC, and SWN) or a natural gas ETF, such as UNG, may find it prudent to be aware of weather as an indicator of natural gas demand and, therefore, price. This past week’s milder than normal weather was a negative short-term catalyst for natural gas and also natural gas producers. Continued mild weather could drag down natural gas prices.