The Divergence Between Oil and Natural Gas Prices

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.”

About Donald Marron 294 Articles

Donald Marron is an economist in the Washington, DC area. He currently speaks, writes, and consults about economic, budget, and financial issues.

From 2002 to early 2009, he served in various senior positions in the White House and Congress including: * Member of the President’s Council of Economic Advisers (CEA) * Acting Director of the Congressional Budget Office (CBO) * Executive Director of Congress’s Joint Economic Committee (JEC)

Before his government service, Donald had a varied career as a professor, consultant, and entrepreneur. In the mid-1990s, he taught economics and finance at the University of Chicago Graduate School of Business. He then spent about a year-and-a-half managing large antitrust cases (e.g., Pepsi vs. Coke) at Charles River Associates in Washington, DC. After that, he took the plunge into the world of new ventures, serving as Chief Financial Officer of a health care software start-up in Austin, TX. After that fascinating experience, he started his career in public service.

Donald received his Ph.D. in Economics from the Massachusetts Institute of Technology and his B.A. in Mathematics a couple miles down the road at Harvard.

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