Oil to Natural Gas Price Ratio

I am hearing a lot of chatter about the price of natural gas, particularly the ratio of the price of oil to the price of natural gas. Historically, the ratio of oil to gas has been 6:1 to 10:1. This week, that ratio soared as high as 26:1.

People are using this ratio as a reason to jump into natural gas, seeing it as extraordinarily cheap relative to oil. But is it? If you look out onto the strip, you will see that the ratio collapses out a few months (click to enlarge).

"M" stands for month out, so "M4" is four months out. The ratio is 14:1 at the end of the year, still high but not as high as it first seems.

If you try to play the convergence of this ratio through the futures market or by owning the UNG, you are betting that the prices of near-term contracts will soar as this ratio should fall just by allowing the futures to roll over.

Now, I do not know if the near-term price of gas will jump. (I placed a bet several days ago that it would bounce as it was very oversold but liquidated the position when it became apparent I was wrong.) However, inventory is swamping the gas markets, and storage is tight, so the price could still go substantially lower. Not saying that it will, rather that sometimes markets can go further for longer than one could imagine.

This is the natural gas strip (click to enlarge).

The horizontal axis is the natural gas futures price for outer month contracts. For example, "ng3" is the natural gas price for three months out, or the November futures contract.

Prices in the outer months have fallen over the past few weeks but less so than the near-term contracts. This is one reason why the stock prices of natural gas companies have held in fairly well even though the spot price of nat gas has collapsed as natural gas producers sell their product across the strip.

Comments

[Ruffdog:]

We are the Saudi Arabia of NG. With the new technology of extracting NG from shale we have it coming out of our ears and almost no place to store it. See link below.
www.eia.doe.gov/oil_ga...
Now we have to develop the NG transmission system to move it from the well to the user. The Northeast, US, as an example, uses heating oil to heat most of their homes. Pennsylvania is the closest NG rock shale to the NE US. If the energy department, our President and congress wanted to stimulate the economy and reduce our dependence on foreign oil, they would propose and support the building of a NG pipeline from, Pennsylvania to New England and give a rebates to each home owner who turned in their oil burning furnace for a NG burning furnace. This is a “no brainer.” It would:
1) Create American jobs; short-term engineering and building the pipeline and long term operating the pipeline.
2) Reduce our dependence on foreign oil homes would not be using oil for fuel.
3) Reduce global warming as NG emits much less CO2 than oil.

Aug 30 09:52 AM

[jay brebner:]

totally agree with ruffdog above. While the Alaska NG pipeline was included in the house and senate bill, other more practical pipeline projects were not even mentioned as far as I can tell, I'm guessing because they were not as close to shovel ready and thus not short term stimulative (?). In fact the bill increases reserves in the Gulf while not addressing transmission to US consumers which are both price destabilizing policies. I would suspect Sen MCConnel's support for coal in Kentucky as a major factor. Plus the Pennsylvania Coal Association (link below) as well as corn producers in the midwest probably have a lot more political clout in comparison to NG producers. This has to change in midterm elections.

We the public need to call for a separate NG infrastructure bill in 2010 that will provide additional stimulus and sane use of resources.

Aug 30 11:50 AM

[bagoff:]

First, why doesn't anybody think oil is too high. You could reduce the ratio if the price of oil dropped. Also supply/production has been exceeding demand for quite a while, I wonder who is proping up the price of oil?

Second, I agree with the comments above. It is interesting that in a lot of the US homes have NG. Interestingly, the government has set extremely high fees for companies to convert cars to NG. If they get rid of the fees and pass a tax credit for the conversion, I think we could convert a lot of gas guzzlers pretty quickly. With home distribution of NG already in place, it shouldn't be that hard to set up a commercial distribution.Cars can be set up to run both gas and NG. Couldn't you refill at home until commercial pumps are in place? I would really like to see a feasibility study. Assuming you could run your car cheaper and cleaner, I think it would only take removing the fees charged to converters and providing a tax rebate on conversions to achieve a lot of our national goals: Reduce dependence on foreign oil, reduce emissions, and create jobs.

I am so sick of politics getting in the way of progress. Why can't politicians do what is right on both sides of the aisle? Mr. Smith needs to go back to Washington. (Its a movie for the readers who are too young to remember black and white movies)

Aug 30 01:03 PM

[leroy brown:]

the ng companies dont want you to be able to fill your tank at home..back in the 80s when a lot of folks converted pickups to propane it was against the law to draw from your own propane tank in the yard...no tax revenue...and the pressure was lower....no one will allow cheap ng to be tapped at the house cause they want tax revenue and the companies dont want dummies to blow themselves up.

Aug 30 04:02 PM

[apppro:]

In more rational and traditional times the above oil:ng ratio would have meant something, but we are now in markets that are the playgrounds for option traders and short sellers - NG is just their latest victim. Sure we have oversupply, but the extreme negativity and deflating prices has more to do with option traders/traitors and naked shorters who moved from the banks over to the commodities. We made it easy for them too boot by making comparisions that no longer have validity - not in this market at least!

And as far as oil goes - well you need to look at the Forex Dollar traders/traitors for that rediculous price. That 26:1 ratio is really meaningless right now.

Aug 30 06:29 PM

[Henri DeToi:]

As usual the government has to find a way to tax it before it becomes readily usable. And the oil companies have to fond a way to divert their billions into natural gas. This is pure capitalism for you; one more reason to have a social conscience so that the rich do not become richer at the expense of the poor. There has to be a level playing field. Furthermore, only the rich have access to university education.

Aug 30 07:54 PM

[Ozarker:]

Two different commodities, two different supply and demand curves. Oil to Natural Gas Ratio is Voodoo economics. They both produce heat when burned and that's about it.

Aug 31 08:38 AM

[Michael Fit...:]

the tradition oil/natural gas ratio is history. it means nothing any longer. reasons:

1) worldwide oil supply will not keep pace with worldwide oil demand. therefore, oil, for the rest of our lives, will be in an upward price ramp (i.e. long-term contango).

2) natural gas is abundant, not just in the U.S., but worldwide

given these two points, and that the US imports 65% of its petroleum, it is simply ludicrous that obama and chu and this country is not totally embracing natural gas transportation and reducing foreign oil imports. we could convert half the cars and trucks in this country to natural gas over the next 5 years, and reduce foreign oil imports by 6-7 million barrels of oil per DAY. this would keep nearly half a billion dollars in the U.S every DAY (at $70/barrel oil). it would also creates millions of jobs. imagine what that one initiative would do to energize the U.S. economy and reduce greenhouse gas emissions at the same time. obama and chu are asleep at the switch!

Aug 31 08:42 AM

[kmi:]

there are companies offering systems to fill up your NG car at home. NG auto conversions are also increasingly becoming more popular, look around web.


On Aug 30 04:02 PM leroy brown wrote:

> the ng companies dont want you to be able to fill your tank at home..back
> in the 80s when a lot of folks converted pickups to propane it was
> against the law to draw from your own propane tank in the yard...no
> tax revenue...and the pressure was lower....no one will allow cheap
> ng to be tapped at the house cause they want tax revenue and the
> companies dont want dummies to blow themselves up.

Aug 31 09:58 AM

[Mad Hedge F...:]

k. mm “When do I buy natural gas” is the most frequent question I am getting from clients these days. I can’t blame them, after watching CH4 dive from $13.50/MCF last year to a September contract low of $2.72. Massive new discoveries and an unusually cool summer is causing a looming storage shortage that has hammered longs. Those who dove in early have been punished, with stop outs followed by stop outs. The bizarre thing is that gas went up in flames while crude more than doubled, from $32 to $77, leaving pros stunned and speechless. The crude/gas ratio has soared to an unimaginable 27 times, up from a mere four times in the last decade. On a BTU basis, gas is now only 25% the cost of oil, it burns cleaner, with only half the carbon dioxide output, and is cheaper than high grade coal. Natural gas at these prices is another way of buying oil at $18 a barrel, with less pollution. Industry insiders don’t see it falling below $2/MCF, the breakeven cost of the longest term producers, where the shut off valves will start creaking en masse. Existing gas fields deplete at 25% a year, and the 60% cut in new drilling this year will deliver a rebound in prices by next winter. Longer term, the Pickens plan and the conversion of a large part of our national power generation to natural gas will drive prices higher. In the end, I think the final low will be defined by another Amaranth type disaster, where a super leveraged long hedge fund gets wiped out and is then liquidated under the worst conditions imaginable. In 2007, the Amaranth debacle took gas from $17 to $4 in the blink of an eye. Where Amaranth 2.0 will take us is anyone’s guess. But when it happens, possibly as early as September, other big hedge funds will stampede in like feral cats lapping up spilled milk. If I lived over a giant salt cavern, I would be pumping it full of natural gas now. But since these formations don’t exist in Northern California, I shall have to content myself with the futures markets, where longer dated contracts are selling at big premiums. Email me at madhedgefundtrader@yah... if you need help getting set up on the futures. For those not looking for an “E” ticket ride, it may now be time to Hoover up the leveraged natural gas equity plays like Chesapeake (CHK), XTO Energy (XTO), Southwestern (SWN), and Petrohawk Energy (HK), which appear to have already bottomed.

Aug 31 10:15 AM

[GMiki1:]

Boone Pickens dropped his plan, I hear. I think nat gas is going higher with so much less drilling and wells capped, once we burn off some supply. How soon with el nino? Who knows, but somehow I think it's worth being in a little nat gas to be contrary.

Aug 31 11:11 AM

[Econ 101:]

T Boone ddnt drop his NG plan. But then it isnt about NG for him it is about water, getting an easment from Texas north to transport and sell water in the midwest and NE

Aug 31 12:05 PM

[jerrydd:]

First off cars are not good for NG because they don't have the space, fear and can't go through tunnels. You can't fill at home because the compressors cost too much and use too much electricity.

Taxes soon will be mileage based as the gov wants taxes from NG biofuels and EV's.

Oil prices are constrained because there is not enough supply once the economy improves. Vs Ng supply is not constrained in the US.
The drop in NG drilling rigs is not a factor as most removed were not eff types. If more supply is needed new rigs can be made, used. As prices for new wells are cheap they are profitable even at $3. And NG is still cheap even at $6-8 for customers.

NG will soon power semi's, other trucks, buses because it's far cheaper, cleaner. Car will go EV and many will be charged from coal plants converted to NG. In Fla 1/2 our coal plants have been converted already.

If we really have such NG supply then GTL plants will pop up making diesel, gasoline and electricity from NG by the F-T process.

In the long run RE like home, small business size wind, CSP solar is and PV soon will be viable keeping the price of coal, oil, NG in check after 10 yrs from now by allowing any homeowner with a good site to make all their own energy for home and transport at very low rates compared to fossil fuels .

Aug 31 12:16 PM

[jerrydd:]

Sorry I meant oil supplies are constrained.

Aug 31 12:19 PM

[Old Trader:]

jerrydd,

I'm not sure where you're getting your facts on the negatives/reasons why cars aren't a candidate for NG conversion. This is VERY old technology. I've got a cousin who was big into hunting, and his vehicle for his trips was an early 70's Chevy Suburban that he converted to dual fuel operation. He could switch fuels "on the fly" by flicking a switch mounted under the dash. With the optional 44 gal. gas tank, and the NG, he had a range of almost 800 miles (the Suburban was a V-8...8 mpg city/ 10-11 mpg. highway.)


On Aug 31 12:16 PM jerrydd wrote:

>
> First off cars are not good for NG because they don't have the space,
> fear and can't go through tunnels. You can't fill at home because
> the compressors cost too much and use too much electricity.
>
> Taxes soon will be mileage based as the gov wants taxes from NG biofuels
> and EV's.
>
> Oil prices are constrained because there is not enough supply once
> the economy improves. Vs Ng supply is not constrained in the US.
>
> The drop in NG drilling rigs is not a factor as most removed were
> not eff types. If more supply is needed new rigs can be made, used.
> As prices for new wells are cheap they are profitable even at $3.
> And NG is still cheap even at $6-8 for customers.
>
> NG will soon power semi's, other trucks, buses because it's far cheaper,
> cleaner. Car will go EV and many will be charged from coal plants
> converted to NG. In Fla 1/2 our coal plants have been converted already.
>
>
> If we really have such NG supply then GTL plants will pop up making
> diesel, gasoline and electricity from NG by the F-T process.
>
> In the long run RE like home, small business size wind, CSP solar
> is and PV soon will be viable keeping the price of coal, oil, NG
> in check after 10 yrs from now by allowing any homeowner with a good
> site to make all their own energy for home and transport at very
> low rates compared to fossil fuels .

Aug 31 08:52 PM

[JG Savoldi:]

You guys seem to have a nice handle on the fundamentals here--and you might be correct in the long term--but our model is suggesting a huge unwind in the LONG CRUDE OIL/ SHORT NAT GAS trade.

So far at least, Crude Oil is tracking the BAM Model (see the article we posted on this site recently) and, if we're correct, we'll see severe downside acceleration in this crash leg.

During 2008, the BAM Model correctly forecast the crash from 147 to 36, let's see if we can get it right again here. Only time will tell.

Sep 01 04:00 PM