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Natural Gas Rises, Key Stocks Rally: Why the Rally Is Unstable

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Natural gas rises, key stocks rally

On March 24, 2016, natural gas futures rose 0.67% to close at $1.81 compared to the previous trading session. On the same day, within the SPDR S&P Oil & Gas Exploration & Production ETF (XOP), natural gas companies with a production mix of at least 80% in natural gas rose an average of 2.7%.

On March 24, Cabot Oil & Gas (COG) and EQT Corporation (EQT) rose 2.3% and 2.4%, respectively. Rice Energy (RICE) and Southwestern Energy Company (SWN) rose 3.3% and 0.45%, respectively.

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Why the rally is unstable

Stocks with a production mix of at least 80% in natural gas (UNG) had a stronger correlation to crude oil than to natural gas between June 20, 2014, and February 11, 2016. On June 20, 2014, WTI (West Texas Intermediate) crude oil futures closed at $107.26 before they started to fall. On February 11, 2016, WTI crude oil touched a multiyear low of $26.05.

EXCO Resources (XCO) operates with a production mix of 88.7% in natural gas. Between June 20, 2014, and February 11, 2016, it correlated 42% with crude oil and 22% with natural gas.

Rice Energy (RICE) operates with a 99.3% production mix in natural gas. In the same timeframe, it correlated 42.6% with crude oil and 38% with natural gas.

The above analysis illustrates the Market’s sentiment toward the fall in crude oil prices. Investors turn bearish even toward stocks with a high production mix of natural gas if crude oil prices fall.

EQT (EQT) and Cabot Oil & Gas (COG) had a significantly higher correlation to natural gas than to crude oil between February 11, 2016, and March 24, 2016. Investors are currently discounting these stocks due to the weak natural gas prices. EQT and Cabot Oil & Gas have production mixes of 90.7% and 93%, respectively, in natural gas. However, during the crude oil downturn, EQT and Cabot Oil & Gas correlated more with crude oil than with natural gas. This indicates that a recovery in natural gas prices alone may not be enough to push these stocks higher. Support from crude oil prices will likely be needed. 

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