Why Natural Gas Should Rally This Winter?

The price of natural gas hiked yesterday by over 11% after it had declined during the previous week. On a monthly scale, the price (short term delivery) of natural gas increased by nearly 15%. The most recent hike was plausibly fueled by Hurricane Sandy that raised the uncertainty around the potential adverse ramifications it could have on pipelines and other gas related infrastructure in the East Coast. Despite the recent rally, the price of natural gas is still low compared to recent years. Will the price of natural gas remain low? I think the recent fundamental changes in the natural gas market will result in a rise in the price of natural gas in the months to follow; I also think this winter the prices of natural gas won’t be as low as they were last winter. If the prices will continue to rise and might even be higher than last year’s, this could also pull up stocks of leading oil and natural gas producers including Chesapeake Energy Corporation (NYSE:CHK) and Chevron Corporation (NYSE: CVX). Let’s analyze why the price of natural gas should rise this upcoming winter.

During October, the price (spot) of natural gas rose by 12.1%; by extension, the rate of United States Natural Gas (NYSEMKT: UNG) also increased by 2.6%. The future price (November delivery) hiked by 14.5%. The rise in prices during October was mostly related to changes in the weather – the rise in temperatures contributed to the increase in the demand for natural gas in the power sector (increase usage in Air conditioners). Further, there was an ongoing fall in natural gas production. These shifts suggest that the natural gas market has tightened. As I will present herein, I suspect will continue.

The chart below shows the recent recovery of the prices of natural gas in recent months.

natural gas prices 2012 Oct

From the demand side, there are expectations by the EIA that this upcoming winter the temperatures will be closer to normal so that the natural gas consumption, unlike last year, will be close to regular demand.

This means the expected demand is likely to be higher than last year, which could also positively affect the price of natural gas.

The chart below shows the developments of the spot price of natural gas against the natural gas storage.

According to the recent EIA report the natural gas storage is still higher than the storage levels from previous years. Even though the storage injections continue to be smaller than in previous years ( you can see in the chart below the moderate upward slope of the storage level in recent months compared to the steeper slopes in previous years) I think the storage level will remain slightly higher than normal – not enough to pull down the price of natural gas.

natural gas and storage 2008-2012 2012 Oct

From the supply side, there are still concerns that the recent Hurricane Sandy could have an adverse effect on the pipelines of natural gas. Once it will become clearer the magnitude of the destruction, if at all, of this Hurricane, natural gas traders could better price in, the effect of the Hurricane to natural gas.

Even if the Hurricane won’t damage any major pipelines or other natural gas related facilities, the supply side is likely to pull up the price of natural gas. There is an ongoing drop in the natural gas production: the natural gas rig count reached, as of October 26th, only 416 – which is less than half the number of rigs only a year back. On the other hand, oil rigs reached 1,382 which are nearly 40% higher than a year ago. This means there is a shift from gas rigs to oil rigs. If the NG production will continue to dwindle, it could suggest the price of natural gas will rise.

Based on the above, I think the natural gas market will tighten in the months to follow which will pull up the price of natural gas. Let’s see the developments in natural gas market with respect to the leading natural gas producers.

Share of Chesapeake also rose during the month by nearly 6.5%. This rally, however, might have been related with the renewed optimism towards the company’s financial circumstances. The company has recently sold another asset – its southern Delaware Basin assets. The total cash the company received from selling its assets sum up to nearly $2.8, which cuts down the company’s existing $4 billion loan to $1.2 billion, as of late October. The company also stated it will repay this loan by the end of 2012. The full loan repayment could further stabilize the company’s financial situation and also the negative market sentiment the company has been having following the decision to take this $4 billion loan. If the price of natural gas will continue to rise, it could also help raise the company’s revenues from natural gas. The company will publish its third quarter reports on November 1st, some analysts are optimistic about the company’s financials than they were in recent months, but I don’t think it will matter much. Only after the company will repay its $4 billion loan it will become clearer the company’s situation and its potential revenue in the months to follow.

Chevron, much like Chesapeake, is also likely to benefit from the recovery of natural gas prices. Nonetheless, the recent drop in the prices of oil and the decline in the S&P500 index have adversely affected Chevron’s stock. During the month, Chevron’s stock declined by nearly 4.6%.  The company will publish its third quarter financial reports on November 2nd.

The chart below shows the shifts in the price of Chevron, Chesapeake and natural gas price (the prices are normalized to January 3rd, 2012). It shows that natural gas has recently passed the price of Chevron’s stock.

Chesapeake chevron and natural gas prices 2012 Oct 23I think the low price of natural gas won’t last long and as the U.S will enter the winter, the price of natural gas will rise again. This rally is likely to be beneficial for major oil and gas producers.

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Disclaimer: The author holds no positions in stocks mentioned and does not plan to initiate positions within 120 hours of the posting of this article. This article is to be used for educational, research and informational purposes only and does not constitute investment advice. There are no guarantees, expressed or implied, of future positive returns in regards to the subject matter contained herein. Understand the risks inherent in investing before making the decision to invest or consult an investment professional for more information. Reasonable due diligence has been performed in regards to the information in this article. However, the author expressly disclaims any liability for accidental omissions of information or errors in fact.