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EXCO Resources Inc (XCO), Chesapeake Energy Corporation (CHK): Can the Natural Gas Rally Continue?

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Natural gas prices are finally on the rise, having soared more than 20% so far this year. On Wednesday, gas prices closed above $4 per million BTUs for the first time since September 2011. Gas prices had remained under $4 per million BTUs for about a year and a half, even sinking below $2 in April last year — the lowest level in a decade.

EXCO Resources Inc (NYSE:XCO)

The rally was fueled by strong heating demand, as cold temperatures across major U.S. metropolitan areas in March kept gas furnaces burning longer than expected. According to Bentek Energy, demand for household heating rose 30% in March from a year ago, as measured by the number of heating degree-days.

With gas prices at their highest level in a year and a half, traders and investors are wondering whether the rally can be sustained. Let’s look at some factors that could lead to a near-term correction in natural gas prices and some of the companies that stand to benefit big time if prices keep climbing higher.

Why the natural gas rally may falter
According to Addison Armstrong, senior director of market research at Tradition Energy, there are four major reasons we could soon see a sell-off in natural gas.

The first is declining demand during spring months. Historically, natural gas demand tends to peak in the winter and fall off during warmer months. Going forward, the combination of reduced demand for home heating and still weak demand for home cooling in the second quarter could contribute to lower prices.

The second reason is an expected increase in nuclear power capacity in the second quarter. The nation’s supply of nuclear energy has declined markedly as much greater capacity has gone off line than expected, mainly for maintenance. However, as Armstrong notes, faster-than-expected progress in maintenance and refueling suggests that the second quarter will see much more capacity coming online than previously thought.

The third is a sharp decrease in the number of power plants replacing coal with gas as their fuel of choice. Over the past year and a half, the trend of utility companies shifting away from coal-fired plants toward gas-powered ones picked up strongly. But now, with natural gas prices much higher and coal prices still very much depressed, this trend is likely to abate.

And finally, there may be some end-of-quarter profit-taking, meaning that traders who were long natural gas this quarter will want to close out their positions to lock in their gains.

Companies benefiting from rising gas prices
If a natural gas sell-off fails to materialize and prices continue to push higher, U.S. natural gas producers will be the most obvious beneficiaries.

Over the past year and a half, energy producers sharply curtailed gas drilling because of the poor economics of their gas wells. For instance, EXCO Resources Inc (NYSE:XCO) slashed its rig count from 23 as of year-end 2011 to seven as of the end of last October.

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