Natural Gas Price Volatility Returning - As Usual

| About: The United (UNG)

Summary

Hottest June on record.

Higher than normal CDDs predicted for this week.

Demand predicted 1.3 bcf/day higher.

Natural gas futures prices becoming more volatile, as usual.

The average June temperature for the Lower 48 states was the warmest June on record, according to scientists from The National Oceanic and Atmospheric Administration's (NOAA) National Centers for Environmental Information. Above-average temperatures spanned the nation from coast to coast, and 17 states across the West, Great Plains and parts of the Southeast experienced temperatures much above average.

Forecast

NOAA's Climate Predict Center (CPC) released its forecast for the week ending July 16th. Based on NOAA's state-by-state cooling degree day forecast, weighted by natural gas-weighted electricity production, I estimate that CDDs will be 17% higher than normal and 13% higher than in the same week last year.

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For the year to date, cumulative CDDs are 13% higher than normal but 2% lower than during the same period in 2015.

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To translate the above NOAA forecast into a natural gas demand perspective, I analyzed the Energy Information Administration's (EIA) June Short-Term Energy Outlook (STEO). The EIA had predicted that natural gas storage would build by 175 billion cubic feet (bcf) in July.

Based on NOAA's forecast for this week, and my demand regression equation (see Methodology below), I estimate that daily demand would be 1.3 bcf higher than it EIA's projection for July. On a monthly basis, that means a lesser storage build by 40 bcf.

Conclusions

The summer has produced the heat as predicted. However, following the strong run in prices, we are now getting more volatility, which is more normal for natural gas futures than a move in one direction.

Methodology

The National Oceanic and Atmospheric Administration (NOAA) provides ongoing assessments and forecasts of population-weight cooling degree days (CDDs). Degree days are based on the assumption that when the outside temperature is 65°F, we don't need heating or cooling to be comfortable.

Degree days are the difference between the daily temperature mean (high temperature plus low temperature divided by two) and 65°F. If the temperature mean is above 65°F, we subtract 65 from the mean and the result is cooling CDDs.

Example: The high temperature for a particular day was 90°F and the low temperature was 66°F. The temperature mean for that day was:

(90°F + 66°F)/2 = 78°F

Because the result is above 65°F:

78°F - 65°F = 13 cooling degree days.

The cooling degree season runs from January 1st through the end of December each year.

Cooling degree days affects natural gas use because it is a feedstock to electric utilities. Electricity powers air conditioners.

Over time, natural gas has been replacing coal as a feedstock to utilities. It follows that to understand how summer temperatures affect natural gas consumption, it is important to know where utilities are burning natural gas and how much.

NOAA produces a population-weighted CDD assessment and forecast for every state and combines them to create a U.S. total. I take this state-by-state CDD data and weight each state by its relative nat gas use at electric utilities. In that way, I get a more accurate picture of Natural Gas Use-weighted CDDs.

To prepare quantitative projections of future consumption, the first step is having a model that relates degree days to demand. In my model, I use three factors: heating degree days, cooling degree days, and GDP.

With just these three factors, I have a 97% multiple regression fit since 2012. This means these factors, each of which is highly statistically significant (as indicated by the T-statistics), explains 97% of the monthly variation in demand (see graph below).

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.