The Disconnect Between Oil and Natural Gas Prices 33 comments
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Thursday marked a new record in the divergence between oil and natural gas prices.
As noted in a small item in the Wall Street Journal, the ratio of oil prices ($ per barrel) to natural gas prices ($ per million BTU) hit a record 24.5 at yesterday’s close. As you can see from the following chart, that’s far out of line with historical norms:
A barrel of oil has roughly 6 times the energy content of a MMBtu of natural gas. If the fuels were perfect substitutes, oil prices would tend to to be about 6 times natural gas prices. In practice, however, the ease of using oil for making gasoline makes oil more valuable. As a result, oil has usually traded between 6 and 12 times the price of natural gas.
That’s changed in recent months. Natural gas prices have fallen to $3.00 per MMBtu, weighed down by new supply and weak demand. Oil prices, however, have stubbornly increased to more than $70 per barrel. That’s down sharply from the $100+ prices of last year, but up sharply from the $40 – $50 range earlier this year.
Where do prices go from here?
History clearly suggests that the price gap will eventually narrow, through some combination of oil prices falling and natural gas prices rising. Over at Econbrowser, Jim Hamilton has some nice statistical work suggesting that natural gas prices have typically played more of a role in such gap narrowing than have oil prices. That would suggest an upcoming increase in natural gas prices but, as Jim notes, they would have to do so in the face of dramatically increased supply.
Jim wrote his piece a month ago and the gap between the prices widened further. So, perhaps not surprisingly, it is very difficult to use these historical relationships to judge short-term prices movements. Over the longer-term, however, I feel confident that demand for natural gas will rise to meet the new supply and that, as a result, the oil vs. natural gas price relationship will eventually move back to normal. Natural gas is cleaner than coal and is available in large quantities in the U.S. and Canada. As a result, natural gas is on the short-list of potential responses to climate change and oil dependence, two concerns that aren’t going away anytime soon.
The chart uses the spot price for West Texas Intermediate at Cushing and the spot price for natural gas at Henry Hub. Both series are monthly, except for the prices from 8/20/09.
Note that I have carefully obeyed the first law of forecasting: I have given a prediction (the relationship between oil and natural gas prices will normalize), but I haven’t given a date.
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but socialism/fascism, this is probaby a good buy.
On Aug 23 11:14 AM ManAboutDallas wrote:
> A plunge in the price of oil? Give your head a shake. How does
> something plunge in price when its supply is decreasing [read: Peak
> Oil] while its demand is inexorably increasing [read: BRIC countries'
> rising demand curve].
>
> Time to stop thinking the world starts at the Statue of Liberty and
> ends at the Golden Gate Bridge.
>
> Couple that with the aberration that oil is still priced in US$,
> declining in value daily now, and about to collapse altogether, and
> the only direction oil is going is.... up.
>
> Sorry if this spoils your lovely, deluded Sunday.
"the ease of using oil for making gasoline makes oil more valuable..." A BTU is a BTU is a BTU if all you're going to do is BURN IT. Boy, I can see this poopooganda comes from Madison Avenue and Wall Street!!!!!! The ease of using Uranium for a nuc plant makes as much sense but not any more valuable.
Ozarker - if the major use of NG, oil, or coal is to BURN IT for it's energy content, the delivered cost/BTU is what matters (assuming the capital cost, environmental cost, downstream costs, etc., are level, which is becoming less true).
nICK36 - IF YOUR argument was accurate, the US would have switched to NG cars decades ago. How much NG does China have access to??? LOTS!! And the gasoline ICE automobile as we know it is going to become a BUGGYWHIP! The rest of the world will show us.
UGH!! The further I go the worse it gets. SA needs to have a logic and fact corrector not a spelling corrector; most of us can read past that. But the other stuff - get's sort of sickening.
Incidentally, the gentleman who thinks that the Saudi's have a "huge amount of excess capacity" should read my new energy economics book. That country would like to go back to the situation the experienced in 2008, when they racked up earnings of almost a quarter of a trillion dollars, but they are getting enough now to become the petrochemical producers that they have always wanted to be. Eventually that excess capacity will produce the oil needed in their new refineries and petrochemical plants.
Good plug for your book. I see the winners going nuclear powered and losers getting lost. All the other choices we will all simply limp or gimp with temporarily until they(we) "get it"...
With all that NG, why is the US still importing LNG from Algiers, etc.? The answer is the to balance supply with seasonal need. Pipelines feeding the southeast, for example, from the Gulf need supplements from Georgia LNG terminals. This "balancing" act is an isolated case given the need to balance the entire US energy consumption equation. Hence the need for a national energy policy the current and past adminstrations have ignored.
A prime example of this need comes from the basic oil cracking process. For every barrel of oil refined there's a finite amount of products produced. About 46% is gasoline, 30% fuel oil (home heating, diesel, etc.), 10% jet fuel, 4% propane, 3% asphalt, 1% naptha, etc. and 6% useless residue. Unless consumption is balanced within this group along with natual gas contribution, critically needed efficiencies and price stabilization cannot be obtained. Using electric and/or NG to propell vehicles in lieu of gasoline will increase the available supply of unallocated (sold)gasoline thus decrease prices . . . . . and around and around we go.
On Aug 23 12:17 PM nakedjaybird wrote:
> Donald Marron - 16 years makes a very short history. Try looking
> at 160 years at a minimum.
>
> "the ease of using oil for making gasoline makes oil more valuable..."
> A BTU is a BTU is a BTU if all you're going to do is BURN IT. Boy,
> I can see this poopooganda comes from Madison Avenue and Wall Street!!!!!!
> The ease of using Uranium for a nuc plant makes as much sense but
> not any more valuable.
>
> Ozarker - if the major use of NG, oil, or coal is to BURN IT for
> it's energy content, the delivered cost/BTU is what matters (assuming
> the capital cost, environmental cost, downstream costs, etc., are
> level, which is becoming less true).
>
> nICK36 - IF YOUR argument was accurate, the US would have switched
> to NG cars decades ago. How much NG does China have access to???
> LOTS!! And the gasoline ICE automobile as we know it is going to
> become a BUGGYWHIP! The rest of the world will show us.
>
> UGH!! The further I go the worse it gets. SA needs to have a logic
> and fact corrector not a spelling corrector; most of us can read
> past that. But the other stuff - get's sort of sickening.
On Aug 23 09:58 AM logicalthought wrote:
> No one hear has raised the possibility that a large portion of this
> discrepancy will be resolved by a plunge in the price of oil. Oil's
> recent rebound was driven not by the fundamental supply-demand equation,
> but by speculation (much of which is well deserved) against the U.S.
> dollar. However, if the dollar rebounds a bit (something which is
> likely to happen just because no one seems to think it will), oil
> could very swiftly return the the $30s or even lower.
The stock market and oil charts may even look like they fell off of cliff. Demand is way, way down and the economy sucks and will only get worse due to a huge continuing credit contraction.
On Aug 23 11:14 AM ManAboutDallas wrote:
> A plunge in the price of oil? Give your head a shake. How does
> something plunge in price when its supply is decreasing [read: Peak
> Oil] while its demand is inexorably increasing [read: BRIC countries'
> rising demand curve].
>
> Time to stop thinking the world starts at the Statue of Liberty and
> ends at the Golden Gate Bridge.
>
> Couple that with the aberration that oil is still priced in US$,
> declining in value daily now, and about to collapse altogether, and
> the only direction oil is going is.... up.
>
> Sorry if this spoils your lovely, deluded Sunday.
Has enough thought been given to the possibility that crude oil has been bid higher by long- term investors seeking declining dollar protection using crude oil futures?
Perhaps the real story is the dollar and until the expectation for a continual decline changes the historical oil and natural gas price ratios may not be very relevant.
Jack
The American consumer accounts for such a large portion of global trade - regardless of how other nations are catching up - that inflation here and a decrease in purchasing power will automatically force commodities into decline in tandem.
That position is terrible for long term investors although the traders will likely make money doing it.
I think the Chinese are hoarding commodities - including oil - as an alternative to dollars and they are going to be one of ones surprised. A hyper inflationary environment with a rapidly declining dollar will hurt everyone, everything, everywhere.
----------------------...
Good luck with your long position in oil. I hope that it is not held in commodity futures contracts. The stock market will fall first, then oil will fall and the Dollar will go up out of fear. Other nations markets will follow or even lead as China's stock market has fallen 20% already.
The stock market and oil charts may even look like they fell off of cliff. Demand is way, way down and the economy sucks and will only get worse due to a huge continuing credit contraction.
On Aug 23 11:14 AM ManAboutDallas wrote:
> A plunge in the price of oil? Give your head a shake. How does
> something plunge in price when its supply is decreasing [read: Peak
> Oil] while its demand is inexorably increasing [read: BRIC countries'
> rising demand curve].
>
> Time to stop thinking the world starts at the Statue of Liberty and
> ends at the Golden Gate Bridge.
>
> Couple that with the aberration that oil is still priced in US$,
> declining in value daily now, and about to collapse altogether, and
> the only direction oil is going is.... up.
>
> Sorry if this spoils your lovely, deluded Sunday
On Aug 23 10:19 PM Gary K wrote:
> Natural Gas is difficult to transport and store.However, I have a
> process that safely converts gasoline into a vapor that is 100 parts
> of air to 1 part of fuel.With this process, the amount of energy
> contained in one barrel of oil would increase by several hundred
> percent.My Avatar-Photo is of just such a device, with the resulting
> vapor ignited to prove that it actually works.Vapor fuel technology
> has been kept very quiet, and the "experts" have repeatedly ridiculed
> it.But again, a picture is worth a thousand words !
That said very little NG is used in transport and I think T Boone Pickens is right about using it in trucks and buses, as electric trucks are not practical and NG is about half to third price of Oil. In many countries NG has been substituted for oil some time ago for heating and electricity to such an extent that Oil is no longer a substituted for NG and therefore there is little linkage in price currently. That will change in the long term as NG becomes a transport fuel, but I think governments are wary of switching from dependence on one fossil fuel to another, as most to worlds NG reserves are in Russia and Iran. This is the position the UK finds itself in now and recently the government has started to realise how vulnerable UK is with about 40% electricity generated from NG and its the main source of domestic heat and energy for industry.
Long term NG has very good prospects but its bit unpredictable at the moment for ETF's, but LNG specialist like BG and companies with NG reserves like Devon should do well.
The best use of natural gas is to convert it to NH3 (anhydrous ammonia), which has a high energy density. NH3 can be used in internal combustion engines with few modifications and emits no carbon dioxide or ozone depleting chemicals - it burn cleans to water.
On Aug 23 09:25 AM dirtyharry wrote:
> One way to get into natural gas in through the ETF trading under
> UNG. However, this is not a perfect substitute for the underlying
> commodity. As the author as stated, when prices will normalize is
> unknown, but when a commodity gets close to its cost of production,
> it tends to stop falling because production ceases to add more inventory.
>
>
> Because of the unknown time frame, one of the best ways to play natural
> gas with with covered calls: Going long (buying) UNG, and then selling
> slightly OTM (out of the money) calls to collect a premium.
It seems abundantly clear to me that the price of oil is completely disconnected from supply, demand and the US dollar idx. This market is controlled by forces that are not linked to supply and demand rather a market controlled by speculators and potential front runners.
In the face of our own financial issues and market meltdowns, the US dollar index has traded with buoyancy and strength. This is directly linked to the US credit-worthiness (i.e. safety). However, as anticipated, the US $ idx is now showing signs of weakness due to the enormous degree of treasuries being pushed into the market (we went from corporate leverage to consumer leverage to what is now US gov't leverage...watch out for how this plays out in years to come). Now that "risk" is being reevaluated and investors are wiling to take on more risk again the US currency is suffering as investors leave the safety of the world's strongest currency and go searching elsewhere for growth potential.
To that end, I can not seem to create a chart, diagram or curve that illustrates any rational relationship between, the US $ and supply and demand. When demand goes down (due to recessionary economic behavior) supply skyrockets and the oil market goes into a state of contango causing the spot price of oil to go down.
When the perception of an economic "recovery" is at hand then the price of oil goes up (inordinately so).
When the threat of a double dip or less the stellar recovery is taken into consideration the oil market falters slightly until the US $ idx seems to be deteriorating, at which point the oil market begins to move higher again due to a weakening in the underlying currency (US $).
Thus, the market seems irrational and no direct relationship can be reasonably drawn between, supply, demand and the US $. While a relationship of some magnitude does undoubtedly exist it is not clear to what extent. As a result, a clear conclusion can not be drawn between spreads, the oil market as a whole and or the NG market. The relationship between NG and oil is too hard to determine with any degree of accuracy so do not expect to be able to eek out some rationale as to when the NG market should rise again as it relates to the spread between oil and NG.
One thing does seem certain though, the old adage of, "expect it when you are least expecting it" may play a role in the NG price recovery. As W.Buffet says..."buy when everyone else is selling".
My guess is that if you started taking small positions in the NG market now, you could be in for a nice surprise in the not too distant future.
Of course, this goes against the grain of reason but how many investors anticipated a 50% recovery in the stock market from March - Aug?...probably none.