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Why milder-than-normal weather impacts natural gas demand

Ingrid Pan, CFA

Natural gas prices are affected by winter weather

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 and, therefore, lower prices. Conversely, colder weather translates into more natural gas demand and higher prices. Natural gas prices 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).

Heating degree days lower than normal last week

For the week ending October 19, heating degree days (as weighted by gas home-heating customers) for the US totaled 61 versus the normal figure for corresponding weeks past of 70. Heating degree days (or HDD) are a measure of how much colder than room temperature the weather is, and the greater the HDD figure, the colder it is. This week’s HDD figure was lower than normal, meaning weather was milder than normal. This implies less natural gas demand and, therefore, lower natural gas prices.

Natural gas prices remained roughly flat on the week, closing Friday, October 18, at $3.76 per MMBtu, as compared to $3.78 per MMBtu a week earlier.

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. The weather in the past several weeks has been warmer than normal, which is a negative indicator. However, the upcoming winter months will be more important to watch, as those are the periods of highest natural gas demand.

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