Weather is a key factor for natural gas prices heading into winter

Natural gas prices are affected by winter weather

Natural gas prices are especially affected during the winter, as many households use natural gas for home heating. Warmer weather translates into less natural gas demand and therefore lower prices. Conversely, colder weather translates into more natural gas demand and higher prices. Natural gas prices affect the earnings of major domestic natural gas producers, such as Chesapeake Energy (CHK), Range Resources (RRC), Quicksilver Resources (KWK), and Southwestern Energy (SWN). Plus, many of these companies are part of the energy ETFs, such as the Vanguard Energy ETF (VDE).

2013.10.15 - Normal vs This Year WinterEnlarge Graph

Heating degree days lower than normal last week

For the week ending October 12, heating degree days (as weighted by gas home-heating customers) for the US totaled 42 versus the normal figure for corresponding weeks past of 56. Heating degree days (or HDD) are a measure of how much colder than room temperature the weather is, and the greater the HDD figure, the colder it is. This week’s HDD figure was lower than normal, meaning weather was milder than normal. This implies less natural gas demand and therefore lower natural gas prices.

However, natural gas prices rose through the week, as the markets anticipated colder weather to come, and natural gas inventories rose less than expected (see Natural gas inventories rose less than expected, a bullish sign). The front month contract for Henry Hub natural gas closed at $3.78 per MMBtu (millions of British thermal units) on October 11, as compared to $3.51 per MMBtu a week earlier.

Colder weather increases demand for natural gas, and higher demand translates into higher natural gas prices, affecting 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.

2013.10.14 - NG vs KWK vs CHKEnlarge 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 week’s milder-than-normal weather was a negative for natural gas demand. However, the markets anticipate colder weather to come and weather will be a more important factor heading into the middle of winter.