Will Natural Gas Change Direction?

The price of natural gas reached its highest level in recent years. The rally of natural gas was mainly due the colder than normal weather and the very low storage levels. Looking forward, will the price of natural gas change direction anytime soon? And, how will the recent rise in the price of natural gas affect the performance of natural gas companies including Devon Energy (NYSE:DVN)?

Natural gas continues to heat up

The recent rally in the price of natural gas is mostly related to the sharp rise in the demand for natural gas for heating purposes due to the colder than normal weather mainly in the Northeast and Midwest. For the 2013-2014 winter, the Energy Information Administration expects the natural gas consumption for heating will be 3.3% higher than last year’s winter. Further, the U.S average heating degrees days, which measure the demand for energy needed to heat a building, will be 3.8% higher this winter than last year’s. Thus, the sharp rise in the demand for natural gas in the residential and commercial sectors has led to high extractions from the natural gas storage.

The chart below shows the changes in the natural gas storage and the weekly price of natural gas in the past several years.

natural gas prices Feb 2014Source of Data: Energy Information Administration

As you can see, the current storage level is at its lowest level in recent years. Further, the current storage is roughly 40% lower than last year. The extraction season is likely to continue until March-April. The current low levels are likely to keep the price of natural gas elevated.

Due to the recent developments in the natural gas market, the Energy Information Administration revised up its estimates for 2014 and predicts the price of natural gas will reach an annual rate of $4.17/ MMBtu — roughly 12% higher than in 2013. The EIA also expects the natural gas production will increase by 2.2% during the year. The consumption is projected to rise to 70.2 Bcf/day in 2014. In the coming weeks, as the temperatures will start to pick up, the demand for natural gas in the residential and commercial sectors is likely to decline. Moreover, the sharp rise in price of natural gas is likely to cut down the demand for natural gas in the power sector.

Investors of the natural gas ETF United States Natural Gas (NYSEMKT: UNG) will only partly benefit from the rally of natural gas mainly due to the Contango in the natural gas market, in which the price of long term future contracts are higher than short term future contracts. The Contango in this market tends to reduce this ETF’s value compared to the price of natural gas.  A more detailed explanation could be found in a recent article I wrote on this issue. Let’s demonstrate the difference between the performance of UNG and the price of natural gas in the following the chart, in which prices are normalized to the beginning of the year.

natural gas Feb 25 2014

Source: EIA and Google finance

The chart shows the prices of UNG and natural gas have parted ways in the past several weeks. This occurrence tends to develop during the winter when the price of the Henry Hub spikes due to sharp changes in the supply and demand. Over long period of time, this gap is likely to further widen. Therefore, investors should be advised to consider this issue when they consider going long on natural gas with UNG during winter time. Other ways to benefit from the recovery of natural gas is by investing in natural gas related companies such as Devon Energy.

Devon Energy

The company’s natural gas production declined in 2013 by 6.8% to reach 873.6 Bcf. Conversely, Devon Energy’s oil production rose by 14.7% during last year. Despite this decline in the natural gas production, the revenue from natural gas still accounted for roughly 31% of the company’s total oil, gas and NGL sales in 2013 — a similar rate as in 2012.

The company’s decision to acquire GeoSouthern Energy’s assets in Texas’ Eagle Ford shale for $6 billion in cash back in November 2013 is expected to further increase the Devon Energy’s oil and NGL production in the coming years. This decision could also reduce the company’s exposure to the changes in the natural gas market. Nonetheless, the recent jump in the price of natural gas is likely to reflect in higher revenue in the first quarter of 2014.


Final note

Natural gas is likely to remain at its currently high level in the near future. But once the temperatures will pick up in March-April, the price of natural gas is projected to come down.  Finally, on a yearly scale, natural gas is expected to be higher than in 2013, which could benefit natural gas companies.

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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.