What Oil and Gas Are Telling Us Now

Includes: CHK, GAZ, OGZPY, OIL
by: Kevin McElroy

Right now, oil and natural gas prices are stretched to their limits. Rarely before in history has oil been so expensive while at the same time, natural gas prices so cheap.

You can see this price differential in effect by looking at this chart, which divides the price of one barrel of oil by the price of one million british thermal units (mmbtu) of natural gas:

It’s helpful to use these types of ratios – that is, the price of one commodity divided by the price of another – to scrub out dollar and currency market fluctuations. It gives you a purer look at the actual relative value of one commodity versus another. The only other time natural gas was as relatively cheap to oil as it is right now happened in last half of 2009.

And in just four months, natural gas prices doubled:

Okay, so there’s one big elephant-in-the-room factor that differentiates the crude oil market and the natural gas market as I’ve presented it in this article. To be brief: crude oil prices are an international phenomenon, because crude oil is traded across borders and across oceans.

But natural gas is largely a local market. As of yet, it’s prohibitively expensive and onerous to ship natural gas across the ocean. I talked about what I dubbed, the “telegraph problem” earlier this month:

It’s the same problem that telegraph companies had in the 1800s: the wondrous new telegraph technology that allowed people to communicate quickly over long distances was stymied by the Atlantic Ocean.

That is, until 1866 when they were able to sink a cable from the United States to Newfoundland to Great Britain.

Today, there are no natural gas pipelines connecting natural gas thirsty Europe and Asia to the massive natural gas resources in the United States and Canada.

I received some thoughtful reader critique on the article above from someone named SeBass:

Have you heard of GAZPROM? They have much much more gas then U.S

And yes, Russia’s gas giant GAZPROM (OTCPK:OGZPY) currently has plenty of natural gas, but they’re pretty much the only game in town supplying not just Russia, but most of Europe with natural gas. As such, natural gas prices in Europe and Russia are 3-4 times higher than they are in North America.

You can imagine how thrilled North American natural gas producers would be to tap the Eurasia market. And essentially, we’re currently in the midst of a telegraph solution away from a North American-Eurasia natural gas market. But we’re not quite there.

In any event, even if North America doesn’t start exporting natural gas to Eurasia anytime soon, the oil-natural gas price differential is still out of wack. Natural gas prices will correct to the upside, and companies that produce natural gas will increase their revenue.

I expect natural gas prices to double sometime in the next 18 months, to put a conservative estimate on it.

My recommendation: nibble on shares of Chesapeake Energy (NYSE:CHK) whenever you can.

Disclosure: No positions