Time to Go Long Natural Gas and Short Oil?

Is it time to short oil and go long natural gas? I posed the question a few days ago and have done a little more digging. The ratio of oil/natural gas prices is reaching extreme historical levels (currently 19.40). Much has been written about recently about the under performance of natural gas relative to other commodities. Tom Lydon notes the ratio is reaching extremes. The chart below from CXOAG shows the ratio dating back to 1976-2008. Note that today we are at a ratio of 19.4



Now take a look at the 3 year chart:



Bespoke notes that the trading volume in UNG has increased dramatically since March, despite the price of natural gas remaining in the doldrums.

Putting all of this in historical context, one has to wonder how much more upside this ratio has...

Disclosures: None.

Comments

[dipps:]

temp oversupply but if we ever get some weather aside from fall hurricanes Nat Gas should turn the corner - heaven forbid we get a long term break in our heating bill - or air conditioning -

Go long term both

Jun 13 10:07 AM

[woolyboogur:]

The ratio is not irrelevant to a user or the economy but since I'm not a trader I can't make a rational comment on that part. It takes about 5600 cu ft of nat gas to get the same amount of energy you get out of burning a barrel of oil. On a Btu basis with gas at $4.00 you get about a million Btu whereas with oil at $72.00 per Bbl you pay $12.4 per million Btu. Oil commands a premium because it is scarcer, not as domestic as nat gas and more subject to geopolitcal problems. Crude is also easier to transport and store and currently the main source of power for transportation land, sea and air. However for power plants, peak shaving and some base nat gas has a huge price advantage over oil but not coal, but it is cleaner burning. The recent shale production of nat gas caught just about every one unaware of its extent and impact. Ten years ago the Alaska Natural Gas Pipeline from the North Slope had to be built but shale delayed that. All the big easy oil has been found and adding reserves is costly. The old tradtional ratio of about 11 is probably what this ratio will oscillate around until we know more and knowing more may never come to fruition. If the country is sensible and makes a concerted effort to convert and make vehilces to use nat gas as well as an infrastructure to "nat gas up" we'll see some good progress. But unless there are more and longer lasting crude crisis, nothing will happen. But traders had an uncanny ability to get crude to $147 last July and would have taken higher but couldn't. Can it happen again, maybe, because no one got caught and sentenced.

Jun 13 10:25 AM

[Rat:]

Since NG is so cheap why aren't we using it more as a replacement for oil products???

Jun 13 10:53 AM

[buddhabill:]

Our energy appetite is voracious and not that elastic. NG will eventually have to close the cost-per-btu gap with oil, (environmental concerns, Pickens plan, etc.) but how far out is 'eventually'? UNG does not appear to be an attractive buy-and-hold due to the costs associated with ETFs, rebalancing, etc.

Any suggestions for a 2-4 year timeframe bullish, moderately speculative play on gas?

Jun 13 12:10 PM

[The-Stock-M...:]

I think the opposite will happen in the near term - NG will fall and Oil will rise. There are some fundamental reasons for it. Oil has been in an upturn for sometime now due to reduction in inventories, most likely due to the summer driving season. Gasoline has been cheap for sometime now, hence folks have dusted off their SUVs once again, looks like. US dollar has been falling steadily for sometime, this moves speculators to commodities like oil, which rise when the dollar falls. Once such a trend starts, more speculators would chime in and push oil even further. Oil has room to go to $100 before hitting the psychological resistance, its now around $70. With fundamental demand still strong, at least till Labor Day, and with dollar continuing its downdraft, looks like oil will continue to rise for sometime to come.
Natural Gas on the other hand has already been pumped up due to the new administration's clean energy push. However, the real demand has probably not started showing, so its mostly hot air now. Real demand for NG would come in winter, used for heating, and whenever the clean energy demand start showing, which maybe months or years from now.

With a limited amount of money chasing energy, we would very likely see a rotation from NG to Oil in the near term, and for all we know, its probably already underway.

Jun 13 03:38 PM

[H. T. Love:]

And if you want to get realy concerned, check out the red line on the chart here.

www.eia.doe.gov/oil_ga...

NG in storage is now *outside* the 5 year moving range.

As I've posted elsewhere, short-term bear, long-term bull.

For now it' not an investment, just a trade.

My Humble Opinion,
HardToLove

On Jun 12 10:17 AM skrangeo wrote:

> I posted this on another UNG article on seeking alpha. In the end,
> those not in the industry have no idea WHY it has decoupled from
> historic levels.
>
> "It's disappointing to keep watching GG pump natural gas and talk
> about "historic relationships to oil". Obviously, Gary is just trying
> to lump in oil and natural gas together as "sister energies" when,
> in all honesty, they aren't. Oil is a global commodity while natural
> gas is relatively a domestic issue.
>
> Furthermore, you can't take "historic ratios" as a barometer because
> in the past there were no massive "resource" plays (a.k.a. shale
> plays). The U.S. is becoming the Middle East of natural gas due to
> the emergence of the Barnett, Haynesville, Marcellus, etc. shale
> plays. They are changing the face of natural gas production.
>
> I find it funny how Gary never addresses the excess supply right
> now.
>
> Snippet from Pickering Holt (oil and gas research firm) talking about
> yesterday's storage data:
>
> "Gas storage recap ($3.93/mcf) – Neutral. 106bcf injection slightly
> lower than Bloomberg expectations but well above typical 85bcf for
> the week after Memorial Day. Still seems like market is 3bcf/day
> oversupplied. Current storage levels of 2,443bcf are 560bcf (+30%)
> above normal and y-ago and 90bcf (+4%) above prior seasonal max levels
> (2006). " "

Jun 13 06:04 PM

[H. T. Love:]

My firm belief is that being long NG _at_this_time_ would be tying up capital that could be more productively deployed. The opportunity-cost is just too great. NG flat until production drops sufficiently

I suggest using the $ to generate some returns elsewhere and when more than 54% of the wells are shut-in, the economy's fundamentals really have "green shoots" rather than "green weeds" (MHO), the consumer has recovered, industrial output has begun some *serious* improvement (increasing electricity demand), the weather becomes less mild (Joe Bastardi calling for mild summer, milder hurricane season, CSU also calling a milder hurricane season), the ratio of oil/NG prices has changed dramatically (what I learned recently is that it was 6/8/10/12:1 depending on who you read), ... well you see where I'm going.

Long-term, I'm bullish on NG. But what I think I see is not near enough to to make an *investment*.

My Humble opinion,
HardToLove

On Jun 12 11:10 AM Larry House wrote:

> I agree with being long natural gas, but I wouldn't short oil on
> a bet. There are just too many ways that could end very badly.

Jun 13 06:14 PM

[H. T. Love:]

Thanks for that. I'd been recently investigating NG/UNG and couldn't explaing some of the activity I saw (because I'm new at all this stuff). I added a link to your comment in my blog to remind me to see if that explains some of the stuff I've been seeing.

Again, thanks,
HardToLove


On Jun 12 01:15 PM tunaman4u2 wrote:

> You have to have serious stones to short oil...
> As for nat gas that inventory number didn't call for that kind of
> response, i thought it was inline & nat gas would be flat...
> it skyrockets & if you bought it you're at a loss now... UNG
> has done that at least 10 times over the last few months. Its usually
> at its low pre inventory report... dont forget the contracts rolling
> soon... people dump the front month that don't want to take delivery
> & pile into month 2 before UNG does...
> So easily manipulated

Jun 13 06:35 PM

[H. T. Love:]

This is really useful information. I've linked your comment into my "Raw Commentary" blog on SA I'm using to piece the puzzle together (I'm really new at al this and still scratching my - now bald - head a lot).

In line with one of your uses, personal transportation, I thought you might find this interesting.

www.capstoneturbine.co...

If you download the video, be aware that it's about 20MB and a slow website, apparently. My "pipe" normally delivers about 1.2MB/s and it still took about 45 minutes. And then it wasn't worth that much to watch it - typical pre-marketing buzz-generation rhetoric and showing the car driving.

I'm long CPST for a long time now, and patient as I believe in the technology and the new management. Anyway, what that article does not mention is that the C30 (and all the Capstone products) are multi-fuel - NG, bio-diesel, land-fill gas (methane IIRC?), etc.

My play will be long more CPST and F (don't laugh - how long do you think it'll take F to bring that over if they have reason to do so?) if the house sub-committees on energy do something rational for a change. With Boone Pickens' Plan getting the publicity it did late last year, I'm hopeful.

I'm still treating NG as a trade-only until I see fundamentals line up better.

HardToLove

On Jun 13 10:25 AM woolyboogur wrote:

> The ratio is not irrelevant to a user or the economy but since I'm
> not a trader I can't make a rational comment on that part. It takes
> about 5600 cu ft of nat gas to get the same amount of energy you
> get out of burning a barrel of oil. On a Btu basis with gas at $4.00
> you get about a million Btu whereas with oil at $72.00 per Bbl you
> pay $12.4 per million Btu. Oil commands a premium because it is
> scarcer, not as domestic as nat gas and more subject to geopolitcal
> problems. Crude is also easier to transport and store and currently
> the main source of power for transportation land, sea and air. However
> for power plants, peak shaving and some base nat gas has a huge
> price advantage over oil but not coal, but it is cleaner burning.
> The recent shale production of nat gas caught just about every one
> unaware of its extent and impact. Ten years ago the Alaska Natural
> Gas Pipeline from the North Slope had to be built but shale delayed
> that. All the big easy oil has been found and adding reserves is
> costly. The old tradtional ratio of about 11 is probably what this
> ratio will oscillate around until we know more and knowing more may
> never come to fruition. If the country is sensible and makes a concerted
> effort to convert and make vehilces to use nat gas as well as an
> infrastructure to "nat gas up" we'll see some good progress. But
> unless there are more and longer lasting crude crisis, nothing will
> happen. But traders had an uncanny ability to get crude to $147
> last July and would have taken higher but couldn't. Can it happen
> again, maybe, because no one got caught and sentenced.

Jun 13 07:02 PM

[H. T. Love:]

You might want to take a look at some of the recent SA posts about oil. Also Zero Hedge's (Tyler Durden) stuff. I'm not experienced enough to judge the truth of the claims.

If they are right, "fundamentals" for oil right now really only consist of things like the JPM lease of a tanker to store oil for future delivery at higher prices (which we know others have been doing for a substantial time now), GS buying *tons* of futures and then forecasting $85 this year and $95 next to drive speculation and line their pockets. That may be why we have the reduction in inventories. It's sitting off-shore waiting for folks to decide when they like the profit margin.

Gasoline prices are rising because refiners are running at almost historically low rates (trying to raise gas price to get back some of the profit they lost last year - and the recent higher crude price reduced their margin *again*). That means they are drawing crude stock at reduced rates. We would have an excess of crude if it wasn't sitting on the tankers.

Has anybody seen any stats on the "driving season"? I haven't (not been looking) but I'd bet that the consumer, in very general terms, is going to be driving much less (savings rate now at 5.6%(?) and climbing and unemployment at 9.4% ought to have *some* effect even if the MSM and government and market keep acting like everything is getting better now and gasoline is down. But still, saw premium at $2.75 recently, not exactly cheap.).

The last few days, the dollar has strengthened. Will it hold? Long-term, I think not, but short-term is anybody's guess. Anyway, almost all the commodities took a hit on that - oil a bit, gold a lot, others varied.

On the NG side, I mostly agree with you. But I think a cause of the NG lag is that all we hear about from BHO's team is "clean coal" and little about NG. Maybe Picken's Plan got into congressional ears though and the energy committee meetings might provide a catalyst for NG.

Any intelligent act by a congressional body would be a welcome surprise.

My Humble Opinion,
HardToLove


On Jun 13 03:38 PM The-Stock-Market-Crash... wrote:

> I think the opposite will happen in the near term - NG will fall
> and Oil will rise. There are some fundamental reasons for it. Oil
> has been in an upturn for sometime now due to reduction in inventories,
> most likely due to the summer driving season. Gasoline has been cheap
> for sometime now, hence folks have dusted off their SUVs once again,
> looks like. US dollar has been falling steadily for sometime, this
> moves speculators to commodities like oil, which rise when the dollar
> falls. Once such a trend starts, more speculators would chime in
> and push oil even further. Oil has room to go to $100 before hitting
> the psychological resistance, its now around $70. With fundamental
> demand still strong, at least till Labor Day, and with dollar continuing
> its downdraft, looks like oil will continue to rise for sometime
> to come.
> Natural Gas on the other hand has already been pumped up due to the
> new administration's clean energy push. However, the real demand
> has probably not started showing, so its mostly hot air now. Real
> demand for NG would come in winter, used for heating, and whenever
> the clean energy demand start showing, which maybe months or years
> from now.
>
> With a limited amount of money chasing energy, we would very likely
> see a rotation from NG to Oil in the near term, and for all we know,
> its probably already underway.

Jun 13 07:37 PM

[The Honest ...:]

I think UNG is a good buy here as I detail on my blog repeatedly that the volume is telling us something.

the honest trader
thehonesttrader.blogsp.../

Jun 13 07:52 PM

[H. T. Love:]

On Jun 13 03:38 PM The-Stock-Market-Crash... wrote:

><snip>
> Oil
> has been in an upturn for sometime now due to reduction in inventories,
> most likely due to the summer driving season. Gasoline has been cheap
> for sometime now, hence folks have dusted off their SUVs once again,
><snip>

For better information about driving and other stuff, I found a post by James Bibbings to SA yesterday

seekingalpha.com/artic...

HardToLove

Jun 13 09:35 PM

[Peter Cooper:]

The contrarian view would short gas and go long oil, and actually this seems more to accord with fundamentals like demand for the product, see this:
arabianmoney.net/2009/.../

Jun 14 12:54 AM

[H. T. Love:]

On Jun 13 07:52 PM thehonesttrader wrote:

> I think UNG is a good buy here as I detail on my blog repeatedly
> that the volume is telling us something.
>
> the honest trader
> thehonesttrader.blogsp.../

I followed the link and read "The problem with commodity ETFs" which happens to mention UNG specifically.

Since that article is recent, June 11, and at the end specifically suggests avoiding UNG,

"... Given this uncertainty we would rather play it from the safe side and reduce the NatGas exposure for the next four days. Furthermore, this will be the first time that the UNG rolls such a position (double the size as a month ago) which means that the managers of the UNG have no practical experience in the rolling of such a large position and of its potential market impact".

What have I missed that suggests investment *now* is good? The volumes being seen may tell you, as an experienced investor, one thing and me, as a n00b, something else.

I *do* believe NG (and maybe UNG) are good long-term investments somewhere down the road. But for me what we're seeing in the volumes smacks of any of: sell-side making a living on the hot topic of BHO's "green initiative", possible manipulation, common sector rotation activities, etc.

All of the above would be easy to do with one or more of:
- GS predicting oil at $85/$95 this/next year,
- the belief that BHO's green initiative will benefit NG (barely a word from the BHO team about NG - mostly wind, coal, electric cars, etc.),
- fund managers being way behind the earnings curve with too much money on the sidelines and believing that the traditional price ratios still apply (ignoring supply/demand of NG right now), etc.

Don't misunderstand - I'm new and really want to know. But I've been working hard at learning and believe the NG will become a valued and profitable investment, just not yet.

Thanks for your thought,
HardToLove

Jun 14 12:32 PM

[H. T. Love:]

On Jun 14 12:32 PM HardToLove wrote:

I forgot to mention the second link *from* your site I followed.

ftalphaville.ft.com/bl.../

That's where the quote came from.

Thanks,
HardToLove

Jun 14 12:41 PM

[Itsonlymoney:]

It seems to me that oil's rise is a result of the dollars decline. NG, on the other hand, is sourced domestically and will not rise until demand increases or supplies fall. I suggest buying companies that explore for and produce natural gas if you think the price will be going up and collect some dividends while you are waiting.

Jun 14 11:01 PM

[htex:]

Not a trader but have interest in NG production. Here what I posted on the other NG article on SA this a.m.

Could Oil/NG pricing ratio be related to the fact that oil is acting as a "safe harbor" commodity (reacting to devaluing of the dollar and possible inflation)? And, NG is behaving so poorly because supply is still being burned off from its peak pricing moment in the summer of 2008 that led to increased E&P. And, demand for NG is down. Further, the folks from the mideast who invested billions in our banks (previously known as investment banks) have oil they would like to sell at a certain price...maybe?

Jun 15 08:26 AM

[Mad Hedge F...:]

This could work. I heard a little tidbit yesterday that makes me feel like I just ate a bad fish taco. Frontline, the world’s largest tanker company, says that it has 100 million barrels in storage, the equivalent of five days of US consumption, the result of the spectacular contango situation that exists in the crude futures market. Traders have been buying front month crude, storing it, and reselling it one year out for non leveraged profits of up to 75%. With spot now at $72.12, and futures for December delivery selling at $75.56, that spread has narrowed to an annualized 9.53%. The last crude top was made by the filling of the Strategic Petroleum Reserve. Could this intermediate top be put in by the filling of the world’s excess tanker fleet? This makes me worried not just about crude, but all of my longs in commodities and their producing stocks, the S&P 500, the BRICK’s, and everything else that has enjoyed a torrid doubling since the beginning of the year. Could gold’s poor performance this week, which dropped from $990 to $935, be the canary in the coal mine? And by extension, is it time to take profits on my short Treasury positions by selling the TBT, which has also doubled? There are just too many charts hanging around their 200 day moving averages to dismiss this lightly. I hate to sound redundant, but selling in May is looking more clever by the minute. Cash is King.

Jun 15 10:26 AM

[Michael Fit...:]

i contend the history oil/natural gas ratio has been broken due to two fundamental developments:

1) peak oil, or alternatively, a future in which worldwide oil supply will not keep up with worldwide demand

combined with

2) abuandant natural gas reserves.

the result of 1 and 2 will be that the oil/nat gas ratio will leave historical trends and move ever higher going forward. this is yet another reason to move the US away from gasoline (oil) based transportation and onto natural gas transportation. the US has abundant, clean, and cheap reserves of natural gas.

Jun 15 10:30 AM

[Ron2008:]

NG is low priced because the specs are short. Today's trading makes that very clear. Specs were dumping every commodity. So most commodities were down. But NG was up because the specs are short NG.

Jun 15 04:54 PM