Must-know: Why natural gas prices fell 6% last week

Market Realist

Why natural gas prices plummeted with other energy commodities (Part 1 of 4)

Natural gas prices dropped sharply last week, giving up some recent gains

The front month contract for natural gas closed at $4.05 per MMBtu (millions of British thermal units) on January 10, a decrease from the prior week’s close of $4.30 per MMBtu. Last week’s drop has partially reversed the gains that natural gas prices have made since early November, when prices were trading at the $3.45 per MMBtu level. As recently as late December, natural gas prices were trading around $4.45 per MMBtu.

Natural gas prices dropped steeply, as the market is expecting milder-than-normal weather in mid-January 2014, which is bearish for natural gas prices. Prior to that, prices had been supported by a sharp cold spell across the nation. For more on why weather affects natural gas, see Why continuous cold weather is positive for 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 large 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 indicators: Prices remain relatively low from a long-term view

This past week, natural gas prices decreased by $0.25 per MMBtu, which is a negative catalyst for natural gas-weighted producers in the short run. Despite the large drop last week, prices are still up 17% 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 the price of natural gas.

Continue to Part 2

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