Must-know: Why a dip in natural gas prices affects energy names
Last week, natural gas prices closed at $4.94 per MMBtu
The front month contract for natural gas closed at $4.94 per MMBtu (millions of British thermal units) on January 31. This was a slightly drop compared to the prior week’s close of $5.18 per MMBtu. Prices dropped on an outlook for milder-than-normal weather, which negatively affects natural gas demand. This lower demand expectation has turned natural gas prices down since last Wednesday, when natural gas prices reached $5.56 per MMBtu.
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Over the past several weeks, colder-than-normal weather and larger-than-expected decreases in natural gas inventory had led natural gas prices to rally. For more on natural gas inventories, please see see Why inventories were roughly in line, but natural gas prices dropped 10%.
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.
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.
Negative short-term but positive medium-term trend: Prices remain relatively low from a long-term view
This past week, natural gas prices decreased by $0.24 per MMBtu, which was a negative signal for natural gas–weighted producers in the short run. However, prices remain up ~40% 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 still remain relatively low, and given the seasonal nature of the recent rally, this trend will likely not translate into a long-term driver.
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.