6 Aug

Why natural gas prices fell given mild weather’s weaker demand

WRITTEN BY Ingrid Pan

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, so demand increases in the summer when people use more electricity for air conditioning. Hotter-than-normal weather can increase natural gas use 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). Additionally, many of these companies are part of the energy ETFs (exchange-traded funds) such as the Vanguard Energy ETF (VDE).

Why natural gas prices fell given mild weather’s weaker demand

Temperatures were milder than average last week

For the week ending August 3, cooling degree days for the United States totaled 62 versus the normal figure for corresponding weeks past of 74. Cooling degree days (CDD) measure 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 the weather was milder than normal, which implies less natural gas demand and therefore lower natural gas prices. On August 2, natural gas prices finished lower at $3.35 per MMBtu compared to $3.56 per MMBtu on July 26.

Theoretically, lower demand translates into lower natural gas prices, which affects the earnings and valuations of natural gas–weighted producers. The graph below 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 natural gas prices fell given mild weather’s weaker demand

Negative short-term catalyst

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 monitor 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. But hotter weather later in the summer could boost natural gas prices.

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