Some like it hot!?

Now that 2016 has decided to deliver record-setting high temperatures across the United States, investors need to consider how these temperatures will affect the spot and forward price of natural gas. Using this information in the coming summer months will allow us to find contango opportunities not only for institutional investors, but individual traders as well. 

Whether you accept global warming or not is irrelevant; it’s hot. It’s hotter than hot. Californians definitely feel it (see: insane California drought) and even here in my home state, northern Alabama has had problems with precipitation as well.

So what does this have to do with commodity prices? Great question.

As you can see in the graph above, natural gas is used for power generation in residences and as the temperatures rise, more and more consumers are inclined to use their air conditioner more than usual. Power plants have to account for this uptick in demand, and produce more electricity for their customers. 

Using the five year average as a benchmark in the first graph, you can see how we’re at the paramount of the trendline, and a continuation of this trend would see new outliers in usage. The increased usage of natural gas for power consumption continues to grow the demand side of the commodity but what about the supply side?

As you can see above, the stored supply is used in cycles, up and down due to its seasonality. It is normal for people to use more natural gas in the winter than in the summer, but if temperatures continue to rise, supply will have to follow suit or we will see an escalation in the equilibrium price. 

In US equities, we’ve seen the energy sector make significant progress from the low crude oil prices of early 2016, and given this rebound, we should expect to see energy firms with market caps that are weighted on natural gas to trade higher through the summer. (Given a late federal reserve interest rate hike.)

Below we see the year/week chart for the energy firm Freeport-McMoran Inc. ($FCX)

Freeport-McMoran Inc. produces oil and natural gas liquids to sell on the open market and 23.1% (about $9.2B) of their market cap is held in these energy assets. You can see how this firm has benefited from the complete reversal in WTI and Brent prices but the new demand in natural gas shouldn’t be ignored.

Another example of a firm highly exposed to natural gas prices is Chesapeake Energy Corp. ($CHK)

Also having benefited from a reversal in oil prices (and an untimely death of CEO Aubrey McClendon), Chesapeake should be on everyone’s radar this summer since it is estimated that 39.8% of CHK’s market cap is wrapped up in natural gas. 

All in all, natural gas is the way to go this summer in my personal opinion. The volatility of crude oil and the ridiculous news coverage surrounding OPEC and its effect on the commodity price is nothing short of press manipulation. Apart from that, output consistency and supply/demand equilibrium in WTI and Brent seem non-existent, even though Saudi Arabia and friends continually to say otherwise. (Don’t even get me started on Iranian production.) 

So as a bit of advice, whether you’re at Goldman Sachs or at your computer in a robe, watch for US securities with high exposure to natural gas prices, and try to ride the demand wave as we move into the autumn months.