Must-know: Why natural gas prices had another strong rally

Market Realist

Why natural gas prices rose while oil and liquids prices fell (Part 1 of 4)

Natural gas prices up sharply on the week, continuing a month-long rally

The front month contract for natural gas priced at Henry Hub closed at $4.35 per MMBtu (millions of British thermal units) on December 13—up significantly from the prior week’s close of $4.11 per MMBtu. Also, natural gas prices are up over 20% since mid-November, when prices were around $3.55 per MMBtu. Currently, natural gas is trading around $4.35 per MMBtu.

Natural gas rose throughout the week as forecasts predicted colder weather would boost natural gas demand (for why weather can affect natural gas prices, see Must-know: Why wintry weather helps boost 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 the price of natural gas.

Positive short-term and medium-term indicators: Prices remain relatively low from a long-term view

This past week, natural gas prices were up, which was a positive indicator. Since mid-November, natural gas prices increased over 20%. 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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