Last week had hotter than normal temps but gas still plummeted

2013.07.01 - 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 hotter than normal which is a positive catalyst for natural gas demand and therefore prices. However, nat gas prices plummeted on higher than expected inventories.

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. Therefore, 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 US. 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 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 29, cooling degree days for the US totaled 83 versus the normal figure for corresponding weeks past of 61. 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 higher than normal, meaning weather was hotter than normal which implies more natural gas demand and therefore higher natural gas prices. On June 28, natural gas prices finished down at $3.57/MMBtu compared to $3.77/MMBtu on June 21, with the bearishness due to higher than expected inventory builds (see “Larger than expected increase in nat gas inventories cause prices to slide”).

Theoretically, higher demand translates into higher 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 whose production is currently weighted towards natural gas. Over the past few years, the equity prices of these companies have trended with natural gas prices.

2013.07.01 - 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 be aware of 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.