The price of natural gas has rallied in recent weeks and has lately passed the $4 mark. Looking forward, will the natural gas market continue to heat up? How the recent rally may affect natural gas producers including Chesapeake Energy (NYSE: CHK) and Anadarko Petroleum (NYSE:APC). Let’s start by reviewing the recent developments in the natural gas market.
Demand and supply of natural gas
During the first eight months of 2013, the total consumption of natural gas remained very close to last year’s consumption. The sharp rise in the residential and commercial sectors was offset by the drop in the power sector. This winter, however, both of these sectors’ consumption isn’t expected to rise compared to last year.
Based on the updated Energy Information Administration outlook , in the upcoming 2013/2014 winter, natural gas consumption is expected to be close to last year’s : The demand in the residential and commercial will fall by 1%, consumption in the power sector will drop by 3%, and industrial production will increase by 3%. On the other hand, the supply is projected to rise by 2% compared to last year’s winter. This trend could loosen the natural gas market compared to last year; it may also curb down the recent rally of natural gas.
Nonetheless, the price of natural gas is likely to rise in the coming weeks as the U.S enters winter season. Moreover, if this upcoming winter were to be much colder than the current forecasts, the price of natural could rise further. If you think of going long on natural gas by buying its ETF, take into account the disadvantage of investing in such an ETF.
Natural gas ETFs
Before purchasing a natural gas ETF such as United States Natural Gas (NYSEMKT: UNG), consider its main drawback: underperforming the natural gas price due to the Contango in the market. This problem is well explained in detail in an early Fool article. A contango is a situation, in which long term future contracts are priced higher than short term contacts. The UNG ETF mostly holds next month’s future contracts — as of this month, its January’s future contract. Before the contract expires, however, the ETF sells January’s future contract in exchange for February’s contract. If February’s contract is higher than January’s, the market is considered, as stated earlier, in Contango . As a result, the value of the investment in the February contract would tend to increase slower than the spot price of natural gas, or decline faster. In other words, when the market is in Contango, the ETF loses money with respect to the movement in the spot price of natural gas. The Contango is likely to continue in the coming months: This trend tends to occur during winter times, as stated by the UNG prospectus .
Moreover, investing in UNG includes a 0.6% management fee. This is another factor that will further lower the return on such an investment.
The chart below shows the movement of UNG and the price of natural gas normalized to the end of last year.
Source of Data: Energy Information Administration
As you can see, the price of natural gas rose by 22% during the year, up to date, while UNG rose by only 6%. Therefore, investors may want to consider alternative investments to UNG such as natural gas producers Chesapeake and Anadarko Petroleum. Let’s review how these companies are doing in the natural gas market.
Chesapeake and Anadarko Petroleum
The rally of natural gas price could benefit Chesapeake in fourth-quarter. In the third-quarter, the company’s [l6] natural gas realized price rose by 15%; its natural gas production declined by 9%. In total, the company’s natural gas revenues slightly rose by roughly 4%. Due to the company’s asset reduction and change in policy, its natural gas production isn’t likely to rise in the fourth-quarter. Based on the company’s current outlook and its performance during the first three quarters of 2013, its natural gas production may reach 260 Bcf, which is a 7% drop from the fourth-quarter in 2013 . The price of natural gas is likely to be only 2% higher than last year. In total, revenues from natural gas may fall by roughly 5%. Despite the drop in natural gas production, natural gas and NGL still account for nearly 48% of Chesapeake’s revenues from production.
Anadarko Petroleum (NYSE:APC) continues to expand its natural gas operations: The company’s natural gas sales grew by 31% during the third-quarter . Most of the growth in sales was from the sharp rise in realized price of natural gas — a 25% rise. The company’s production grew by roughly 5%. The volume of production is expected to remain elevated this year. One of the reasons for the rise in production is the commencement of Anadarko’s 200-million-cubic-feet-per-day Brasada natural gas processing plant . The moderate rise in the price of natural gas along with the expected rise in production could positively affect its natural gas revenues in the fourth-quarter.
These two companies are likely to benefit form the rally in natural gas prices in the coming months. They could also serve as alternatively investments to UNG.
Takeaway
The natural gas market is heating up for the winter time, and the sharp rise in prices is likely to continue in the coming weeks. But the current weather forecasts suggest the demand for natural gas won’t sharply rise this winter. This could result in a slowdown in the recent rally of natural gas price. Nonetheless, the ongoing recovery of natural gas is likely to benefit companies such as Chesapeake and Anadarko Petroleum.
For further Reading see:
- Why Coal Isn’t Going Anywhere
- Will Natural Gas Remain Low in 2013?
- Is Chesapeake walking towards the right path?
- Why the Recent Rally in Natural Gas won’t help XOM
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.