Why higher oil and gas prices are helping energy company valuations

Part 2
Why higher oil and gas prices are helping energy company valuations (Part 2 of 4)

Must-know: Why natural gas prices rebounded 7% last week

Last week, natural gas prices recovered by 7% from previous week drop

The front month contract for natural gas closed at $4.33 per MMBtu (millions of British thermal units) on January 17, a 7% increase compared to the prior week’s close of $4.05 per MMBtu. Natural gas prices had been volatile over the past few weeks. In late December, natural gas reached nearly $4.50 per MMBtu, then fell to $4.00 per MMBtu in early January before rebounding recently to current levels.

2014.01.21-Natural Gas PricesEnlarge Graph

Natural gas prices grew sharply despite the milder-than-normal weather last week, as the market was expecting a forthcoming cold storm at the week of January 21, which is bullish for natural gas prices. For more on why weather affects natural gas, see Why this colder-than-average winter has helped natural gas prices.

Natural gas prices are especially important for domestic independent upstream names whose production largely includes natural gas such as Chesapeake Energy (CHK), Southwestern Energy (SWN), Comstock Resources (CRK), and Quicksilver Resources (KWK).

Natural gas price movement is also relevant for commodity ETFs such as the U.S. Natural Gas Fund (UNG), an exchange-traded fund designed to track the price of Henry Hub natural gas (the standard benchmark for domestic natural gas prices).

Natural gas prices are low from a long-term perspective

From a long-term historical perspective, natural gas has been trading at low levels over the past few years. Prior to the financial crisis of 2008, natural gas had reached peaks of over $15.00 per MMBtu. Since 2008, a considerable amount of natural gas supply has come online without an equivalent increase in demand due to the discovery and development of large natural gas shale resources in the United States. Many investors expect natural gas prices to remain relatively depressed, as the development of shale resources has allowed companies to produce natural gas economically at lower prices.

2014.01.21-Natural Gas Prices LREnlarge Graph

For companies weighted towards natural gas assets and production, prices have an important effect on valuation

Market participants and upstream energy companies monitor natural gas prices because lower prices translate into lower revenues—and therefore lower margins and valuation for natural gas producers. The chart below shows natural gas prices plotted against CHK’s and KWK’s stock prices over time on a percentage change basis. The graph shows that the companies’ valuations closely relate to natural gas prices.

2014.01.21-Natural Gas vs. CHK vs. KWKEnlarge Graph

Positive short-term and medium-term indicators, but prices remain relatively low from a long-term view

This past week, natural gas prices increased by $0.28 per MMBtu, which was a positive catalyst for natural gas-weighted producers in the short run. Plus, prices are up 25% since early November, which is a positive medium-term trend for natural gas prices. From a wider long-term perspective (five years and longer), natural gas prices are relatively low. Fluctuations in natural gas prices most affect natural gas–weighted producers, such as the companies mentioned above (CHK, SWN, CRK, and KWK), and the U.S. Natural Gas Fund ETF (UNG). Investors with such holdings find it prudent to track natural gas prices.

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