Why cool weather heading into fall weighs down natural gas demand

Demand for natural gas rises in the summer, when power plants generate more electricity to fuel cooling needs

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. So hotter-than-normal weather can increase natural gas usage 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 per MMBtu (millions of British thermal units) to ~$3.30 per 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). Many of these companies are part of the energy ETFs such as the Vanguard Energy ETF (VDE).

Why cool weather heading into fall weighs down natural gas demand

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Temperatures were milder than average last week

For the week ending August 17, cooling degree days for the United States totaled 54 versus the normal figure for corresponding weeks past of 68. 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 lower than normal, meaning weather was milder than normal. This implies less natural gas demand and therefore lower natural gas prices. Despite mild weather, on August 16, natural gas prices finished slightly higher, at $3.37 per MMBtu compared to $3.23 per MMBtu on August 9, as the reported build in natural gas inventories was less than expected (please see Natural gas prices up on better-than-expected inventory figures).

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 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.

Why cool weather heading into fall weighs down natural gas demand

Negative indicator

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, and prices traded lower. Hotter weather later in the summer could boost natural gas prices. But the summer heating season is coming to a close, and with each passing week the probability of this boost decreases.

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