Must-know: Why natural gas traded flat despite hotter than normal temperatures

2013.07.07 - CDDEnlarge GraphElectricity generation uses a great deal of natural gas, so demand for natural gas increases in summer months, when air conditioning use is heavy

Natural gas is a major fuel used in electricity generation, so demand increases in the summer, when people use more electricity for air conditioning. As a result, hotter than normal weather can increase natural gas use and consequently natural gas prices. For example, during the summer of 2012, much of the United States experienced record-hot temperatures. Cooling degree days from the week ended May 5 through the week ended September 29 totaled 1,311 compared to an average of 1,079. During that period, natural gas prices rallied from ~$2.30/MMBtu (million British thermal units) 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 (exchange-traded funds), such as the Vanguard Energy ETF (VDE).

Last week, temperatures were hotter than normal, which is a positive catalyst for natural gas demand and therefore prices—and natural gas traded slightly higher

For the week ending July 6, cooling degree days for the United States totaled 77 versus the normal figure for corresponding weeks in the past of 67. Cooling degree days (CDD) measure 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 higher than normal, meaning weather was hotter than normal, which implies more natural gas demand and therefore higher natural gas prices. On July 5, natural gas prices finished up slightly at $3.62/MMBtu compared to $3.57/MMBtu on June 28, with some support from a slightly smaller than expected build in inventories (see Why the slight move up in natural gas inventories was positive for stocks).

Other things being equal, higher natural gas demand results in higher natural gas prices, which increases the revenues and earnings of natural gas producers

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

2013.07.07 - NG 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 monitor weather as an indicator of natural gas demand and therefore price. This past week’s hotter than normal weather was a positive short-term catalyst for natural gas and also natural gas producers, though prices traded lower on inventory figures. Hotter weather later in the summer could boost natural gas prices.