Will Natural Gas Continue to Recover?

The natural gas market heated up in the past several weeks as the extreme cold weather in the Northeast and Midwest increased the demand for natural gas. Will the price of natural gas continue to rise?  How will the latest developments in the natural gas market affect the performance of leading natural gas producers such as Chesapeake Energy (NYSE: CHK) and Devon Energy (NYSE:DVN)?

Natural gas market is heating up

During the first ten months of 2013, the total consumption of natural gas was only slightly lower than last year’s demand. The consumption in the residential and commercial sectors grew by 18% and 12%, respectively. The rise in consumption in those sectors, however, was offset by the 13.5% decline in demand in the power sector.

The colder than normal weather in the U.S resulted in a staggering increase in demand for natural gas in the residential and commercial sectors during recent weeks. The table below shows the total and average weekly extraction rate from the natural gas working underground storage from November to mid-January. As you can see, the depletion rate in the past couple of months was the highest in recent years. If this depletion rate remains higher than previous years’ pace, this could keep pressuring up the price of natural gas this winter.

natural gas prices Jan 2014

Source of Data: Energy Information Administration

For 2013, the Energy Information Administration estimates the total consumption to be 2.1% higher than in 2012 — a record high of 71.2 billion cubic feet per day. The lower than normal temperatures during the 2013/2014 winter along with the low storage levels are likely to keep the prices of natural gas elevated in the coming weeks.

Another factor that could have pressured up the price of natural gas is the drop in supply: The EIA reported several well freeze-offs due to extreme cold weather conditions in parts of the U.S. The current cold weather could result in additional well freeze-offs, which may further tighten the natural gas market and raise the extraction pace from storage.

But on a yearly scale, the EIA estimates the demand for natural gas will decrease by 2.2% mainly due to lower heating degree days and decline in natural gas usage in the power sector. This could mean that during 2014 the natural gas consumption will drop to 2012 levels.

Conversely, the natural gas production is projected to rise by 2.1% during 2014. Therefore, the natural gas market is expected to loosen during the year, which is likely to bring natural gas prices down to below normal levels.

During this winter, however, long terms investors might not fully benefit from the recovery of the natural gas market if they were to invest in natural gas ETFs such as United States Natural Gas (NYSEMKT: UNG). Because of the Contango  in the natural gas market — when prices of long term future contracts are higher than short term future contracts — the ETF’s value decreases.  This drop in value occurs when the ETF switches at the end of each month its near month natural gas future contracts for next month’s contract. AI more detailed explanation could be found in a recent article I wrote on this subject. UNG also addresses this issue in its prospectus  and claims this situation tends to occur during winter. Nonetheless, investors of natural gas could use UNG as a short term investment, in which the adverse effect of the Contango isn’t severe. E.g. in the past two months the gap between UNG and the price of natural gas was less than a half of one percent.  Let’s see how the recent developments in the natural gas market may affect leading natural gas companies. 

Chesapeake and Devon Energy

Chesapeake, the second largest natural gas producers in the U.S, has cut down its natural gas production by roughly 24% in 2013, year over year. Oil production is estimated to increase by more than 31%. In the fourth-quarter, natural gas production is expected to drop by 28%. Further, the price of natural gas reached an average of $3.86, which is roughly 8.5% higher than the price of natural gas in the same quarter in 2012. Thus, the drop in production will more than offset the rally in the price of natural gas.

Nonetheless, during January 2014 natural gas jumped by 26.5% compared to January 2013. Looking forward, if the price of natural gas remains at its current high levels, it could have a strong positive effect on Chesapeake’s revenue and profitability in the first-quarter of 2014.

Devon Energy is also likely to benefit from the recent recovery in the natural gas market.  Devon Energy, much like Chesapeake, reduced its natural gas production and raised its oil production during 2013. During the first nine months of 2013, the company’s natural gas production fell by 7%, while its oil production rose by 14%. Therefore, the recent recovery of natural gas will have a lesser positive effect on the company’s revenue than it had in previous years.

In conclusion

Natural gas is likely to keep recovering in the coming weeks as the demand for natural gas further rises. Natural gas producers such as Chesapeake and Devon Energy are likely to benefit from this rally and show an increase in revenues in the first-quarter of 2014. But on yearly scale, the natural gas market is expected to cool down, which will pressure down the price of natural gas.

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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.