Higher commodity prices are positive for energy companies' earnings (Part 1 of 4)
Natural gas prices continue to rally, up nearly 30% since early November
The front month contract for natural gas closed at $4.42 per MMBtu (millions of British thermal units) on December 20—up from the prior week’s close of $4.35 per MMBtu. Additionally, natural gas prices are up nearly 30% since early November when prices were around the $3.45 per MMBtu level.
Natural gas rose throughout the week as last week’s report on inventories showed that natural gas stocks had dropped much more than expected. For more on natural gas inventories, see Why natural gas prices rose to their highest point since July 2011.
Natural gas prices are especially important for domestic independent upstream names whose production largely includes natural gas such as Chesapeake Energy (CHK), Southwestern Energy (SWN), Comstock Resources (CRK), and Quicksilver Resources (KWK).
Natural gas price movement is also relevant for commodity ETFs such as 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).
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.
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. The graph demonstrates that the companies’ valuations are closely related to the price of natural gas.
Positive short-term and medium-term indicators; prices remain relatively low from a long-term view
This past week, natural gas prices were up, which was a positive indicator. Since early November, natural gas prices increased by nearly 30%. 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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