Winter Weather, OverZealous Cold Computer Models for Natural Gas and Other Weather Related Commodities
The winter of 2016-2017 has been one of the most "volatile" as far as weather forecasts go for U.S. natural gas demand, and hence commodity prices and the subsequent moves in ETF's such as UNG, BOIL and FCG. Too many weather forecast firms have been touting a weak La Nina and various events in the stratosphere and oceans would portend a much colder winter and hence higher natural gas prices. We too have fallen into this occasional trap. The lack of Midwestern and Northeastern snow cover has also caused model errors, a warm January and the recent fall in natural gas prices. There have been occasional cold outbreaks (as will be the case next week) but the pattern has been Jekyll and Hyde.
With respect to soft commodities and grains, the global weather pattern for production has been much more consistent. This can be seen for example in the cocoa market (NYSEARCA:NIB), in which we became bearish 6 months ago on a consistent rebound of global cocoa crops. Most recently an improved weather pattern for South American soybeans (NYSEARCA:SOYB) has pressured this market, while Robusta coffee (instant coffee whose beans are grown in Vietnam, Northeast Brazil and Indonesia) has suffered weather problems and hence higher prices for more than a year. Most recently, however, our Climatech long range commodity weather forecast program is predicting an improvement in the drought in NE Brazil for parts of February (climatepredictanalytics.com).
There is no ETF for Robusta coffee, but Arabica coffee (NYSEARCA:JO) (grown mostly in Central America, Colombia and Brazil) did experience a bit of a price rise because of the NE Brazil drought and rally back in the Brazilian Real. Most recently, we advised clients to take profits on the long ETF because of our uncertainty if upcoming rains and a big Colombia crop might cause the coffee market to top out.
So what about the rest of winter and natural gas? In my opinion? Volatile, too difficult to trade in the short term and many varying factors with respect to weather, vs. lower wells, production coming down, etc. Most research I have done suggest fairly high confidence for a cold late winter and potentially an improving ski season in the eastern U.S. If so, natural gas prices might bottom in the days or weeks ahead, but any major move higher of let's say 20-30% will depend not only on late winter weather, but if the summer is hot (not as likely as last summer), and what happens with overall production in the months ahead.
Which Natural Gas Companies are the most/least correlated to Futures Prices and the Weather?
These companies have had the highest correlation in their stock price to the natural gas futures contract. With U.S. weather so volatile this winter, it may take a severe late winter cold snap to help these stocks rally. A severe late winter cold snap, if it occurs, will at least put a floor on some of these stocks
▪Antero Resources (NYSE:AR) - 65.6%
▪Gulfport Energy (NASDAQ:GPOR) - 61.1%
▪Rice Energy (NYSE:RICE) - 53.5%
▪Range Resources (NYSE:RRC) - 49.3%
▪Southwestern Energy (NYSE:SWN) - 37.7%
The following natural gas-weighted stocks correlated the least with natural gas futures during the same period:
▪WPX Energy (NYSE:WPX) at -0.6%
▪Cabot Oil & Gas (NYSE:COG) at -12.1%
Southwestern Energy is one stock which has underperformed many other energy companies in recent months.
Southwestern Energy primarily operates in the Fayetteville Shale in Arkansas and the Marcellus Shale in Pennsylvania, which are predominantly natural gas fields. In fact, the Fayetteville Shale was discovered by Southwestern Energy.
Almost ~89.0% of Southwestern Energy's operating revenues from product sales come from natural gas. So movements in natural gas prices have an immediate impact on SWN stock. Some of SWN's peers are Gulfport Energy (GPOR), CONSOL Energy (NYSE:CNX), Range Resources. Most of these firms hedge themselves in natural gas futures, swaps, collars and puts in order to protect their cash flows and stabilize targeted revenue returns.
Almost all upstream companies are involved in hedging, but their hedging effectiveness varies due to derivative coverage, hedge types and hedge prices. For example, for 3Q16, upstream companies such as W&T Offshore (NYSE:WTI), California Resources (NYSEMKT:CRC) and Stone Energy (SGY) have a negative hedging effectiveness of -0.38%, -3.3%, and -0.21.0%, respectively.
Chesapeake Energy's (NYSE:CHK) everyone always asks about is not as directly correlated with weather and hence natural gas prices as the stocks mentioned above. CHK has the highest debt-to-equity ratio among its peers at about 813%. Rice Energy's ratio is the second-highest debt-to-equity ratio among its peers, and it's significantly lower than CHK's debt-to-equity ratio. QEP Resources is one of the few companies that pays dividends.
Presently, about 10% of Wall Street analysts rate Southwestern Energy as a strong buy and 65% as a hold. I like looking at certain stocks that are affected by weather and commodity price movement, when analysts are heavily bullish or bearish in one direction and then looking for reasons to do the opposite. While contrary opinion does not always work, give me a major change in commodity prices and I will say with high confidence that most analysts are wrong and the stock price will go the other way. An example, the last time natural gas reached $6.00 during the first quarter, 2014, following the coldest winter in years and many of the above mentioned natural gas stocks had a significant winter 2014 rally.
The key point to all of this is to listen to weather forecasts in coming weeks. If it appears that there will be some "consistency" in the weather forecast for a change to colder late winter weather, then some of the above mentioned stocks could closely mimic a rebound in natural gas prices. However, any major precipitous move is unlikely for the moment, given that most of the country has not been cold and we will be entering a typical weak demand period going into the spring. What will be influencing the U.S. late winter weather pattern? Click here.
Also, stay connected to my website in future months, as I will be offering a special FREE report "Weather and how to Trade Commodity ETFs and Options."
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. I have no business relationship with any company whose stock is mentioned in this article.
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