A 'new normal' for oil and natural gas prices?
In previous posts (most recent here), I noted that oil and natural gas prices have disconnected from their usual historical relationship. For many years, oil prices (as measured in $ per barrel) tended to be 6 to 12 times natural gas prices (as measured in $ per MMBtu). That ratio blew out to more than 20 in late 2009, briefly receded toward more traditional levels, and then expanded again. At Tuesday’s close, the ratio stood at 19.4, far above its historical range:
(Note: 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 thus tend 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 higher.)
The unusual pricing of the last two years reflects two factors. First, there has been a dramatic–and welcome–expansion in domestic natural gas supplies. That’s driven natural gas prices down to less than $4 per MMBtu at yesterday’s close. Second, there is limited opportunity for energy users–utilities, businesses, and homeowners–to switch from oil to natural gas. Years ago, such switching linked oil and natural gas prices relatively closely. But today those prices appear largely decoupled.
All of which poses an important question for investors, forecasters, and industry planners: Will historical relationships eventually reassert themselves, perhaps by longer-term fuel switching by utilities and transportation fleets to natural gas? Or is this time really different, with old pricing relationships no longer relevant?
One way to answer that question–or, at least, to get some insight into how others are answering it–is to look at futures prices. As illustrated in dark blue above, those prices imply that the ratio of oil to natural gas prices will remain well above historical levels for at least the next eight years. The new normal, according to futures markets, will be for oil prices to average about 15 times natural gas prices.
Add/view comments on this post.
------------------------------
The Christian Science Monitor has assembled a diverse group of the best economy-related bloggers out there. Our guest bloggers are not employed or directed by the Monitor and the views expressed are the bloggers' own, as is responsibility for the content of their blogs. To contact us about a blogger, click here. To add or view a comment on a guest blog, please go to the blogger's own site by clicking on the link above.
