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Have crude, natural gas prices divorced? New article in The Energy Journal examines whether the current run of high oil, low gas prices indicates a permanent 'decoupling' Wesley Loy For Petroleum News
A major trend seen in recent years is the wide gap between the price of crude oil and the price of natural gas. While oil prices have skyrocketed, the gas price has gone in the other direction.
A new academic paper published in The Energy Journal, a quarterly publication of the International Association for Energy Economics, examines the trend and tries to make sense of what some suggest could be a “permanent rupture” in the historic relationship between oil and gas prices.
The authors, David J. Ramberg and John E. Parsons, are with the Massachusetts Institute of Technology.
Their paper, titled “The Weak Tie Between Natural Gas and Oil Prices,” says past studies have established that oil and gas prices are “cointegrated,” such that when the oil price rises we see a similar increase in the gas price.
But starting four years ago, the authors write, “the world witnessed a remarkable decoupling between these two prices.”
At the end of December 2008, the price of crude stood at $32.35 per barrel and gas was $5.44 per million British thermal units, a ratio just under six.
Subsequently, the oil price climbed while gas declined. At the end of 2010, the price of oil reached $91.38 per barrel with gas at $4.23 per million Btu, for a ratio just above 21.
So, the authors ask, what has happened to the strong tie between the prices?
Not so simple “It seems natural to imagine that the price of oil and the price of natural gas would tend to rise or fall in tandem,” the paper says. “They are both energy carriers, with one barrel of crude oil having approximately the same energy content as six million Btu of natural gas. This rough logic would argue that the price of a barrel of crude oil should equal six times the price of an mmBtu of natural gas. If the price of natural gas rises by $1/mmBtu, then the price of crude oil should rise by $6/bbl.”
But it’s not that simple.
“The two fuels have different costs of production, transportation, processing and storage, and they serve different portfolios of end uses with only a modest overlap,” the authors write.
Complicating the relationship are short-term variables such as the seasonal fluctuation in the price of gas, and its sensitivity to severe or mild winter weather. The price of oil, in contrast, is not seasonal, the authors write.
But the big factor undermining the simple relationship between oil and gas lately is “there is much more volatility in the natural gas price than can be accounted for by movements in the oil price.”
This volatility is unexplained, the authors say.
Recurring theme “This is not the first time the natural gas price has appeared to decouple from the oil price,” the article says. “Throughout the 1980s and early 1990s, the United States experienced a so-called ‘gas bubble’ — an excess supply of deliverable gas — that kept natural gas prices low relative to the then prevailing price of crude oil. The situation reversed itself in the late 1990s and early 2000s so that the price of natural gas was regularly above the level one might have predicted based on the historical relationship. Both times there was industry talk of a decoupling.”
A graph with the article plots Henry Hub gas prices and the West Texas Intermediate oil price from 1991 to 2010. It shows general alignment of the two, though with occasional radical swings higher or lower for gas. As the authors observe, “the eye can spot some rough relationship between the two price series.”
The authors, of course, eventually come to the subject of shale gas.
“A major technological innovation in recent years has been improvements in horizontal drilling and hydraulic fracturing making possible the low cost exploitation of natural gas in shales,” they write. “Production from shales has dramatically increased in the U.S. in recent years, and is almost certainly the cause of the most recent drop in the price of natural gas relative to oil.”
Decoupling not complete Through modeling, the authors attempt to better characterize the relationship between oil and gas prices.
In the end, they seem to arrive at a basic truth: The future is uncertain.
“These results support the hypothesis that whatever relationship might characterize the prices of natural gas and oil, that relationship is not stable over long periods of time,” the authors write. “Earlier researchers documented a statistically reliable relationship through a window of years when the price of gas shifted upward relative to the price of oil, and we have documented a statistically reliable relationship during subsequent years when the price of gas was lower relative to the price of oil. Today’s tie between the price of natural gas and the price of oil may not be very predictive of tomorrow’s tie.”
The authors add that “there is not yet any evidence that the relationship between the two price series has been severed completely. Indeed, it is hard to imagine that natural gas and oil prices could decouple completely and permanently. For example, while conversion of gas to liquids may seem expensive now, the technological possibility of conversion does place a cap on the degree to which oil prices can rise relative to natural gas prices. Other technological and economic constraints act similarly to prevent a complete decoupling.”
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