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Why natural gas prices reached their highest point since June 2011

Ingrid Pan, CFA

Why winter weather could affect your energy holdings (Part 1 of 2)

Winter weather affects 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 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), 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 lower than normal last week but have been higher than normal for the winter so far

For the week ending December 21, heating degree days (as weighted by gas home-heating customers) for the U.S. totaled 205 versus the normal figure for corresponding weeks past of 192. Heating degree days (or HDD) measure 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.

Despite milder weather during the week, natural gas prices rose, as during the week, natural gas inventories dropped far more than expected. See Why natural gas prices rose to their highest point since July 2011 for more background. Natural gas prices rose from $4.35 per MMBtu to $4.42 per MMBtu during the week.

Plus, cumulative heating degree days since the beginning of October have totaled 1,564 in comparison to average heating degrees to date of 1,520. During this period, natural gas prices have experienced a strong rally, from ~$3.60 per MMBtu to current prices to $4.40 per MMBtu.

Theoretically, higher demand translates into higher natural gas prices, which affects the earnings and valuations of natural gas–weighted producers (and vice versa, in that lower demand means lower prices). 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, 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 therefore prices.

Continue to Part 2

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