Why another week of warm weather helped natural gas prices

Market Realist

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 more electricity is used 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). Plus, many of these companies are part of the energy ETFs such as the Vanguard Energy ETF (VDE).

(Read more: Why you should consider risks before investing in the Utica Shale)

Temperatures were hotter than average last week

For the week ending September 14, cooling degree days for the United States totaled 63 versus the normal figure for corresponding weeks past of 41. 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 higher than normal, meaning weather was hotter than normal. This implies more natural gas demand and therefore higher natural gas prices. Hot weather helped to push up natural gas prices earlier last week.

Theoretically, higher demand translates into higher natural gas prices, which affects the earnings and valuations of natural gas–weighted producers. The above graph 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.

(Read more: 2Q13 earnings calls were positive for Utica Shale investment)

Outlook

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 the weather as an indicator of natural gas demand and therefore price. This past week’s hotter-than-normal weather was a positive short-term catalyst for natural gas and also natural gas producers, and prices traded higher. A last burst of hot weather this summer could lift natural gas prices. But the summer heating season is coming to a close, and with each passing week, the probability of this boost decreases.

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

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