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 price of natural gas at the Henry Hub was about $3 per MMBtu. The ratio of the two prices was at record levels, with the oil price 24.5 times the natural gas price.
Oil prices have declined since then, closing at $68.24 per barrel yesterday. But natural gas prices have also declined, closing at $2.82. As a result, the price ratio remains above 24, much higher than the 6 to 12 that’s been normal in recent decades.
To provide some more insight into what’s going on, I made a new graph to show the path of oil and natural gas prices since the start of 2001:
The chart (squiggle, if you prefer) tracks the path of monthly average oil prices along the horizontal axis and monthly average natural gas prices along the vertical, plus yesterday’s closing data. Several features of the graph leap out:
- As expected, the two prices are positively related, with high oil prices generally being accompanied by high natural gas prices, and vice-versa. Most notable, perhaps, are the period of low prices early in the decade (lower left of the chart) and the period of very high prices in 2008 (upper right).
- Sometimes the relationship breaks down, however. Natural gas prices skyrocketed in late 2005, for example, without much movement in oil prices.
- Today, the divergence runs the other way. Natural gas prices are remarkably cheap in absolute terms and relative to oil prices, at least in spot markets.
To drive that last point home, note that the last time natural gas prices were below $3.00 per MMBtu, oil prices were below $30 per barrel. Similarly, when oil prices have been near $70, natural gas prices have been around $6.00.
In response to my previous post, several readers asked whether there was any obvious way to profit from this divergence in prices. Well, one way is to buy natural gas today, put in it storage, and hope to sell it in the future at a higher price.
There’s just one problem with this strategy: People are already doing it. As a result, natural gas storage facilities are close to overflowing. As Monday’s Financial Times reports, that creates a risk that spot prices will fall even further. Indeed “a 2006 gas glut in the UK briefly pushed wholesale prices there below zero.”
Great graph! A wonderful example of what can be imparted very quickly with a chart.
This would seem to strongly indicate there are other forces besides the free market in at least one of these commodities.
Thanks Bill. I presume you are hinting at speculative forces in the oil market? If so, I’d have to say that’s an interesting hypothesis, but in this case, I don’t think it’s the key driver of the disparity. Rather, it appears that we have a straight-up glut of natural gas at the moment. That’s why people are trying to store it anywhere they can.
Donald
A barrel of crude oil is equivalent to between 5.5-6 million BTU per barrel. The general rule of thumb is 6:1 price of gas to get a back of the envelope crude oil equivalence.
Put another way, $3.00 per MMBtu would “equate” to about $18/bbl of crude. Still a big difference but not 24x
Regards
Hi JCH —
The 24 is just the ratio of the reported prices, not adjusting for Btu content. As noted in my earlier post, the ratio usually hangs out in the 6 to 12 range. At 6, as you note, the two fuels would be trading at the same price on a Btu-equivalent basis. In practice, though, oil usually trades higher because it’s high energy density makes it more valuable (e.g., for liquid fuels). With NG below $3 and a usual ratio of 6x to 12x, that would imply a comparable oil price of less than $18 to $36; instead, we are up in the high $60s.
Fair enough
missed the earlier post
You are correct re: energy density and the magic of volume increases from cracking a constant mass of crude
the comparison is against dry gas (ex-NGLs) but this is all practical minutiae relative to your powerful, overarching point.
Best, JCH