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Why did natural gas prices spike above $6 last month?

Ingrid Pan, CFA

Why this cold winter helped energy names like Range Resources (Part 1 of 2)

Weather and natural gas prices

Natural gas prices are especially affected during the winter, as many households use natural gas for home heating. Warmer weather translates into less natural gas demand, resulting in lower prices. Conversely, colder weather translates into high natural gas demand and higher prices. Natural gas prices affect the earnings of major domestic natural gas producers, such as Chesapeake Energy (CHK), Quicksilver Resources (KWK), Range Resources (RRC), and Southwestern Energy (SWN). Also, many of these companies are part of energy ETFs, such as the SPDR Oil & Gas Exploration and Production ETF (XOP).

Heating degree days were higher than normal last week

For the week ending March 8, heating degree days (as weighted by gas home-heating customers) for the U.S. totaled 201 versus the normal figure of 154 for prior weeks. Heating degree days (or HDD) measure the difference between the outside temperature and room temperature to help calculate the demand for energy needed to heat a given area. A greater HDD figure represents colder weather. This week’s HDD figure was higher than usual, meaning weather was colder than normal. This implies more natural gas demand and, therefore, a general increase in natural gas prices.

Despite a colder-than-normal week, the onset of spring and the end of cold weather weighed on natural gas prices. The front month natural gas contract closed at $4.62 per MMBtu last week, compared to $4.61 per MMBtu the prior Friday, and $6.14 per MMBtu two weeks prior.

Cumulative heating degree days since the beginning of October have totaled 3,676, compared to average heating degree days to date of 3,477. During this period, natural gas prices experienced a strong rally, from ~$3.60 per MMBtu to peak last week over $6.00 per MMBtu before falling to current levels of around $4.60 per MMBtu.

Theoretically, higher demand translates into higher natural gas prices (and vice versa, in that lower demand means lower 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, RRC, KWK, and SWN), an ETF containing producers of natural gas such as the SPDR Oil & Gas Exploration and Production ETF (XOP), or a natural gas ETF such as the United States Natural Gas Fund (UNG) may find it prudent to monitor weather as an indicator of natural gas demand and its prices.

Continue to Part 2

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