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. So 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).
Temperatures were slightly hotter than average last week
For the week ending August 24, cooling degree days for the United States totaled 67 versus the normal figure for corresponding weeks past of 63. Cooling degree days (CDD) are a measure of 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. On August 23, natural gas prices finished higher at $3.49 per MMBtu compared to $3.37 per MMBtu on August 16, also helped by a positive inventory report (please see Smaller-than-expected inventory build supports natural gas prices). However, note that as autumn approaches, traders see few catalysts for natural gas prices as hot weather comes to an end.
Theoretically, higher demand translates into higher natural gas prices, which affects the earnings and valuations of natural gas–weighted producers. The below 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.
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 be aware of 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. Hotter weather later in the summer could boost 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: An Introduction to Oil and Gas Hedges: Collars)
More From Market Realist