Why Natural Gas Should Rally This Winter

Lior is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The price of natural gas hiked the other day 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, which 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 the commodity 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 continue to rise and even go higher than last year’s, this could also pull up stocks of leading oil and natural gas producers, including Chesapeake Energy (NYSE: CHK) and Chevron (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, this is something I suspect will continue.

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

<img src="/media/images/user_12845/natural-gas-prices-2012-oct_large.jpg" />

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 that of 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 natural gas storage.

According to the recent EIA report, 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 – though not enough to pull down the price of natural gas.

<img src="/media/images/user_12845/natural-gas-and-storage-2008-2012-2012-oct_large.jpg" />

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

Even if the Hurricane didn’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 natural gas production: as of Oct. 26, the natural gas rig count reached only 416 – which is less than half the number of rigs only a year ago. On the other hand, oil rigs reached 1,382, which is nearly 40% higher than a year ago. This means there is a shift from gas rigs to oil rigs. If NG production continues 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 the natural gas market with respect to the leading natural gas producers.  

Shares 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 is 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 that it will repay this loan by the end of 2012.

The full loan repayment could further stabilize the company’s financial situation, as well as the negative market sentiment the company has been having following the decision to take this $4 billion loan. If the price of natural gas continues to rise, it could also help raise the company’s revenues. The company will publish its third quarter reports on Nov. 1, and while some analysts are more optimistic about the company’s financial situation 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 will Chesapeake's situation become clearer.        

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&P 500 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 Nov. 2.

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

<img src="/media/images/user_12845/chesapeake-chevron-and-natural-gas-prices-2012-oct-23_large.jpg" />

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

For further Reading see: Is Chesapeake walking towards the right path?

liorc has no positions in the stocks mentioned above. The Motley Fool has the following options: long JAN 2013 $16.00 calls on Chesapeake Energy, short JAN 2014 $15.00 puts on Chesapeake Energy, long JAN 2014 $20.00 calls on Chesapeake Energy, and long JAN 2014 $30.00 calls on Chesapeake Energy. Motley Fool newsletter services recommend Chevron. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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