CL / NG -> inf.

Historically, the price ratio between oil and natural gas has been around 7:1. Back in July, James Hamilton wondered whether the ratio was sustainable above 15:1.

As I write, it is almost 27:1. I believe we have only seen ratios above 20 for brief periods following little events like wars in the Middle East. And I am not sure the ratio has ever been this high.

No, I do not know what it means. If I had to guess, I would guess that lots of small and medium players are betting that the ratio will normalize, and that they are getting squeezed by the larger players. If so, this would provide a great example of how our modern system of derivatives on derivatives on derivatives actually does damage by making the real, underlying markets less efficient.

Of course, I am just guessing. Maybe there is a good fundamental reason why someone is paying 27x the price for hydrocarbons with 6x the energy content. Theories welcome.

4 comments to CL / NG -> inf.

  • jus me

    I recall reading that a LOT of Exxon-related NG was going to come online.
    Found this on google
    http://texadalng.com/2009/06/exxons-weapon-of-gas-destruction.html
    .
    “In Exxon’s case, valuable liquids also produced in its Qatari projects take the market breakeven price of the natural gas itself “towards zero,” … Factoring in processing and shipping costs, that gas can be landed in the U.S. for less than $2 per million British thermal units”
    .
    The energy content vs price angle is interesting, but probably, they’re different markets. (eg, I guess you can get gasoline/aviation fuel/etc from crude, probably not so easy from straight NG.)

  • bob

    Well, we should all know there is no such thing as a natural or objective price to anything. While NG has pretty much a single use (energy), oil can be used for at least three high-demand products — energy, plastic, fertilizer. So would it be the case that if the old ratio was 7:1 when the two were both primarily used for energy only, that the new ratio when oil has 3 times as many uses is 21:1? I’m just kidding actually, as the ratio of oil used for those three products isn’t 1:1:1, but you get my point. If NG producers want to make more money per unit, they need to find another market for their product. There seems to be a good reason though that the old ratio of 7:1 would not last. I have no way to calculate what the new ratio should be, though.

  • bob –

    So would it be the case that if the old ratio was 7:1 when the two were both primarily used for energy only, that the new ratio when oil has 3 times as many uses is 21:1?

    In a word, no.

    For there to be a “natural” relationship between the prices of two commodities, they do not need to be interchangeable for all purposes… They only need to be interchangeable for some purpose. If it is cheaper to use natural gas for even one activity — energy production, say — then more and more natural gas will be used for that activity until either (a) it is no longer cheaper or (b) that activity only uses natural gas.

    If these natural gas and oil prices do not normalize, within a few years we will all be driving CNG vehicles, and the amount of oil used for energy production will be 0%.

  • jus me

    “If it is cheaper to use natural gas for even one activity — energy production, say — then more and more natural gas will be used for that activity until either (a) it is no longer cheaper or (b) that activity only uses natural gas.”

    Sure, but the infrastructure isn’t set up to switch quickly. Plants that can run on either have (doubtless) already switched to natural gas. To change all oil-based energy production plants to NG would take decades, and many billions in new investment.
    The “it” in “it is no longer cheaper” is more than just the price of the input fuel. Consequently we are at your option (b) “that activity only uses natural gas”
    where “that activity” is defined as all those uses that can be switched without massive new investment of both time and money.

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