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The Disconnect Between Oil and Natural Gas Prices

August 21, 2009 by Donald

Yesterday 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:

Ratio of Oil to NG (August 21 2009)

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.

Note: 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.

P.S. 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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Posted in Energy, Environment | Tagged Energy, Natural Gas, Oil | 12 Comments

12 Responses

  1. on August 21, 2009 at 11:11 am Anthony W. Orlando

    Nicholas Semeniuk has a good explanation of this trend at http://www.anthonyworlando.com/2009/07/09/demystifying-the-commodity-crescendo/.


    • on August 21, 2009 at 5:58 pm Donald Marron

      Thanks Anthony, that’s a helpful link.


  2. on August 25, 2009 at 10:11 pm Natural Gas and Oil Divergence « jcullen3

    […] (proxy ticker: UNG) have undergone such a divergence of late.  Professor Donald Marron shows that the historical trading range — where crude typically trades at 5x to 10x the price of natural gas — has been blown […]


  3. on August 25, 2009 at 10:45 pm Energy Is Still Key Driving Force In International Politics And Trade « Culture of Life News

    […] Marron, a former member of the Council of Economic Advisers, wrote in an Aug. 21 posting on his […]


  4. on September 2, 2009 at 12:04 am Another Look at Oil and Natural Gas Prices « Donald Marron

    […] 2, 2009 by Donald Marron A couple weeks ago, I discussed the remarkable divergence between the prices of oil and natural gas. At the time, the spot price of West Texas Intermediate was above $73 per barrel, while the spot […]


  5. on September 2, 2009 at 5:05 am The Divergence Between Oil and Natural Gas Prices

    […] couple weeks ago, I discussed the remarkable divergence between the prices of oil and natural gas. At the time, the spot price of West Texas Intermediate was above $73 per barrel, while the spot […]


  6. on September 2, 2009 at 3:15 pm Rex Tillerson : Natural Gas Is Cheap Compared to Oil

    […] Gas Is Cheap Compared to Oil Donald Marron submits:A couple weeks ago, I discussed the remarkable divergence between the prices of oil and natural gas. At the time, the spot price of West Texas Intermediate was above $73 per barrel, while the spot […]


  7. on April 1, 2010 at 6:51 pm Oil and Natural Gas Prices Disconnect Again « Donald Marron

    […] 1, 2010 by Donald Marron Last summer I noted that oil and natural gas prices had diverged to an unprecedented degree. I bravely predicted that this divergence would reverse (unbravely, I didn’t predict […]


  8. on April 2, 2010 at 5:37 am Oil and Natural Gas Prices Disconnect Again | Reaction Radio

    […] summer I noted that oil and natural gas prices had diverged to an unprecedented degree. I bravely predicted that this divergence would reverse (unbravely, I didn’t predict […]


  9. on April 2, 2010 at 6:02 am Oil and Natural Gas Prices Disconnect Again | Commodities Reporter

    […] summer I noted that oil and natural gas prices had diverged to an unprecedented degree. I bravely predicted that this divergence would reverse (unbravely, I didn’t predict […]


  10. on April 5, 2010 at 6:46 pm Oil and Natural Gas Prices Disconnect Again | Stocks and Sectors

    […] summer I noted that oil and natural gas prices had diverged to an unprecedented degree. I bravely predicted that this divergence would reverse (unbravely, I didn’t predict […]


  11. on April 22, 2010 at 3:52 pm Haywood Cheesman

    I always enjoy reading intelligent articles by an individual who is obviously up to snuff on their chosen subject. I’ll be following this thread with great interest. Keep up the great work, see you next time



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