Natural gas continues downward slide

Market Realist

Natural gas prices closed down on the week

Natural gas spot prices closed at $3.23 per MMBtu (millions of British thermal units) on August 9th—down $0.12 from the prior week, when they closed at $3.35 per MMBtu. The commodity was trading at levels as high as ~$3.80 per MMBtu in mid-July, and this is the third week in a row that natural gas prices have closed lower. Lower natural gas prices are a negative catalyst for energy stocks—especially domestic independent upstream names where production largely includes natural gas, such as Chesapeake Energy (CHK), Southwestern Energy (SWN), Comstock Resources (CRK), and Quicksilver Resources (KWK). Lower natural gas price movement is also negative for 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). Prices were largely driven down by milder than normal weather; see Natural gas prices remain depressed with no help from mild weather for more.

(Read more: Why ethane stopped trading like crude and started trading like nat gas (part II))

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.

(Read more: Why ethane stopped trading like crude and started trading like nat gas (part III))

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. It appears that the companies’ valuation has tracked the price of natural gas quite closely.

(Read more: An Introduction to Oil and Gas Hedges: Collars)

Negative short-term catalyst, prices at lowest levels since February

This past week, natural gas prices were down sharply, which was a negative short-term catalyst. Furthermore, natural gas still remains close to 2013 lows, as prices slid throughout May and June, and also decreased sharply over the past few weeks. Lastly, 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.

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