A Crude Conundrum
If there is one ratio in the commodities market that completely out of whack, it has to be the price of crude ($wtic: chart) to natural gas ($natgas: chart).
From 2000 to the end of 2005 the ratio of the crude oil price in $/bbl to the price of natural gas in $/MMBtu was around 7:1.
Today, that ratio is a little over 18:1.
The price of crude oil started its ascent towards record highs in 2006, and natural gas supplies started creeping upwards, also to record highs about that same time.
If one were thinking about the ratio alone, you’d surmise that either crude prices need to fall or natural gas prices need to rise to trend back towards that 7:1 ratio. The problem with this logic is that crude and natural gas now contend for markets with drastically different scopes.
Crude is truly a global commodity as evidenced by the geography of the crude reserves and the intercontinental demand for the black gold from the Middle East. Natural gas on the other hand is very localized, and this is due primarily to the transportation and infrastructure differences between the two energy resources.
Natural gas is relegated to pipeline transportation (with the exception of limited LNG movement via ships) whereas crude oil is fit for pipelines, freighters, tankers, rail…
So you can start to see the conundrum.
The holy 6:1 ratio (based purely on energy content) is not so holy any more, and natural gas and crude have devolved into completely unrelated markets.
For now.
I suspect that if we continue to see natural gas supply levels stay up, and prices stay low, that more and more industries will shift to natural gas for purely economic reasons.
I predict that natural gas draws will start increasing this winter, and the price will reflect that.
As for the ratio, I suspect it will start to moderate, but not because crude oil prices start retreating.
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totally agree, the ratio has blown out for the list of reasons you listed. FYI the worst way to play this trade is via the UNG and USO or whatever the short version of the USO is. prolly futures is the only way you can bet the ratio reverts, or try to find exposure to nat gas via equities while staying away from the oil heavy majors.
here is the ratio according to futures charts going out to 2017
NG CRUDE RATIO
2009 5.369 72.47 13.49785807
2010 6.779 77.95 11.49874613
2011 7.174 80.48 11.21828826
2012 7.319 82.57 11.28159585
2013 7.484 84.73 11.32148584
2014 7.629 87.03 11.40778608
2015 7.779 89.43 11.49633629
2016 7.924 92.52 11.67592125
2017 8.089 95.02 11.74681666
heres another quick question, does the price of the 2012 future tell us where oil prices will be in 2012?
crap, no one like my question, i was busy yesterday celebrating the dump in oil prices ( yes i am short), and now i’m busy trying to cry myself to sleep after crude rallied nearly all its losses back.
that being said, i’ll answer my own question.
the price of futures beyond the actual cash mkt and effectively front month future are NOT AT ALL INDICATIONS OF WHERE PRICEES WILL BE.
the difference between the price of crude today and the price of the future in 6/9/12 months tells you how much it will cost to store crude oil bot today.
if the nearby future price is higher than the further out contracts, this tells you that people want crude oil now and no one will pay to store it.
this is a common misconception when people look at the futures mkts, hope this helps anyone who was ever confused
I figured Winston would chime in there, but guess not…
Yes, there is a huge misconception on the futures markets and what they represent in terms of actual future crude prices. The media doesn’t help things either, and they certainly don’t explain that fact outright.
Great explanation, hayek, thanks!
Grant