Northeast Heat Wave Sends UNG Soaring

by on July 6, 2010 | ETFs Mentioned:

Traders returning to work after a long Fourth of July weekend have been greeted by scorching temperatures across much of the Northeast, with the National Weather Service even advising that the early July heat wave could produce “a dangerous situation.” An excessive heat advisory went into effect for a handful of Northeastern cities on Monday, and is expected to remain in place for several days as high humidity levels and triple digit temperatures blast the region. Highs in New York City were expected to range from 100 to 102 degrees on Tuesday, prompting the city to set up “cooling stations” offering refuge from the heat.

Other major U.S. cities are also under siege from skyrocketing temperatures; Philadelphia, Washington, and Baltimore  are all under heat advisories, as are large areas of New Jersey, northern Virginia, and New Jersey.

The rash of higher-than-normal temperatures have prompted concerns of heat-related illnesses or even deaths, bringing back memories of a 1980 heat wave that killed more than 1,200 people along the East coast. The almost unbearable conditions have inhabitants of affected cities longing for a wave of storms to move through later this week and provide relief. But investors in the United States Natural Gas Fund (UNG) are cheering news of the heat wave, and hoping the blistering temperatures hang around for a while.

As a result of the heat wave moving through the eastern part of the country, air conditioners in the entire region are running at full blast. That translates into a spike in power demand, which in turn increases the need for natural gas-fueled power plants. “Hot temperatures increase gas demand as mostly gas-fired power plants are called on to meet spikes in power demand caused by air conditioning usage,” writes Mark Peters. “Prolonged hot spells can make a dent in gas storage levels, which have been strong amid increased production from shale gas formations.”

UNG In Focus

The United States Natural Gas Fund (UNG) was surging on Tuesday, climbing more than 4.3% in late morning trading. UNG utilizes a futures-based strategy to offer investors exposure to natural gas prices; the fund’s current holdings consist of August contracts. By investing primarily in near month futures contracts, UNG offers investors exposure to natural gas; the fund exhibits a near-perfect correlation with spot prices. But it also has the potential to incur a material “roll yield” when it sells expiring contracts and purchases longer-dated futures each month, a factor that has historically caused UNG to lag the hypothetical return on spot natural gas prices.

After plummeting for most of 2009 and the first quarter of 2010, UNG has staged an impressive rally in recent weeks, thanks to a combination of worries over an active hurricane season, a spike in temperatures, and strong demand from domestic factories [see Five Drivers Of UNG's Spring Rally]. In addition to monitoring thermometers in New York and Philadelphia, gas investors have kept a careful eye on the Gulf of Mexico, where a low pressure area near the Yucatan Peninsula has a 30% chance of developing into a tropical cyclone before the end of the week. Because a significant portion of domestic natural gas supplies originate in the Gulf of Mexico, a storm in the region could result in a major supply disruption.

Look for UNG to be very active over the next two weeks; investors will be eagerly awaiting inventory reports due out this Thursday and next to evaluate the impact of the recent heat wave and a potential tropical storm on supplies.

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Disclosure: No positions at time of writing.