Is The Price of Natural Gas Heading to a New High?

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The price of natural gas continues to rally. Will its rally end anytime soon? How will the recent recovery of the price of natural gas affect leading oil and gas producers such as Chesapeake Energy (NYSE: CHK). Let's analyze the latest developments in the natural gas market and examine what’s next.

During March and April (up to date), the price of natural gas spiked by 22.2%. Moreover, the natural gas ETF United States Natural Gas (NYSEMKT: UNG) also sharply increased by 21.1%. If the natural gas market continues to heat up, then UNG is likely to follow and keep rising. So, will the natural gas market keep heating up?

Storage

The natural gas storage fell below the five year average in recent weeks after it was higher than the average in the past couple of years. The current storage is almost 4% below the five year average. The sharp fall in storage was stemmed by the higher than normal withdrawal rate for this season. During March and April (up to date), the withdrawal from storage was 410 Bcf. In comparison, during the same time frame in 2012 the total injection was 54 Bcf. Last year, however, was among the hottest winters in recent decades, which could explain the short extraction period. If the natural gas extraction rate from storage is an indication for the demand for natural gas, then the demand this season is higher than in previous years.

The chart below presents the development of the underground storage and average weekly price of natural gas. 

<img alt="" src="http://g.fool.com/editorial/images/32656/natural-gas-prices-april-2013_large.jpg" />

Production

According to recent EIA monthly report, the total production declined in January by 0.9%. The drop in production may have contributed to the recovery of prices of natural gas. As of last week, the U.S production slightly declined (week-over-week). If the production will continue to dwindle, it could eventually pressure the price of natural gas to rise. The ongoing decline in the production may adversely affect the growth in sales of leading gas producers.

Chesapeake took a beating from the sharp drop in the price of natural gas during 2012. The company’s natural gas sales in 2012 fell by 36%. The fall in sales led the company to a cash flow problem that Chesapeake still faces today.

Despite the drop in sales in 2012, the company’s natural gas production rose last year by 12%. This year, however, the company updated its natural gas production: the production is expected to fall by roughly 5% to 5.5%. Perhaps the recent rally in the price of natural gas will lead the company to augment its production as the year will progress. Moreover, the company's expected annual average of $3.67/mcf, which is nearly 13% below the current price of natural gas. If the price will remain above the $4/mcf, the company’s outlook will be revised upward. Let’s turn to the recent developments in the demand for natural gas.

Natural Gas and Heating

The demand for natural gas for heating purposes was still high for the season on account for the lower than normal temperatures in the Northeast and Midwest. The heating degrees days were higher this season than in previous years. This was another indication for a high demand for natural gas for heating during March. In the coming weeks the temperatures are expected to rise, which could curb the demand for natural gas and thus pull down the price of natural gas.

Natural Gas and Electricity

The electric market accounts for nearly 40% of the usage of natural gas in the U.S.The other main energy source for electricity is coal. The sharp rise in the price of natural gas in recent weeks may steer away electricity suppliers such as Public Service Enterprise Group (NYSE: PEG) from natural gas to other resources. The company (opens pdf file) produces electricity by using natural gas, nuclear power and coal. If the price of natural gas will continue to rise, it might eventually lead these companies to switch to coal or other energy sources.

In 2012, PSEG’s natural gas share out of the total electricity it generated was 32%. This was a three percent point gain compared to the company’s usage of natural gas in 2011. Back in 2012, the price of natural gas tumbled down to $2/mcf. So the rise in usage in natural gas may have come from the drop in prices. This year, however, based on the current price of natural gas, the company might rely more on nuclear power, which accounted for 57% of its electric generation, and coal, which accounted for 11% of the company’s electric generation in 2012 (it was 15% back in 2011) rather than on natural gas. If other electric companies will shift from natural gas to other resources, the price of natural gas might come down.

Foolish Bottom Line

If the weather won’t start to heat up in the Northeast and Midwest, then the price of natural gas will continue to rally. Based on the current projections, however, the weather will remain cold in the Northeast but the heating degrees are projected to fall. This could cool down the natural gas market in the coming weeks. The sharp rise in the price of natural gas might steer away electric companies from natural gas and switch back to coal, nuclear power or other energy resource. Therefore, I think the price of natural gas might start to lose altitude and pull down in the coming weeks.

For further Reading see:

Is Chesapeake walking towards the right path?

Why the Recent Rally in Natural Gas won’t help XOM


Lior Cohen has no position in any stocks mentioned. The Motley Fool has the following options: Long Jan 2014 $20 Calls on Chesapeake Energy, Long Jan 2014 $30 Calls on Chesapeake Energy, and Short Jan 2014 $15 Puts on Chesapeake Energy. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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