Tuesday, July 29, 2008

Crude Oil and Natural Gas Prices Reliably Intertwined?

The next two home heating seasons are shaping up to be financially brutal for homeowners. Heating degree days will be colder than the thirty year average and any disruption in natural gas supply will have us at $20.00 gas by Dec. '09. There's a reason we posted "Centaurus, Carlyle Carve Gas Caverns as Traders Bet Prices Rise" and:
From our Aug. '07 post, Investing in Natural Gas:

Natural gas futures are down.
The September contract is trading at $5.82 down 21 cents.
The January '08 was $8.20. If you know anyone with (large) gas storage capacity (besides Uncle Dave on a fishing trip) drop me a line....

From CXO Advisory:

Reader Henry Bee of Vancouver, Canada asks:

"You have probably heard of the historical 6:1 crude oil/natural gas price ratio. This relationship is said to be mean reverting based on the thermal equivalence of the two commodities. Does this ratio have any predictive power for the future prices of oil or natural gas? If there is no predictive power for this ratio, then it could mean that the thermal equivalence itself shifts over time. And hedge funds who are long natural gas right now are making a huge fundamental mistake."

If there are relationships, we hypothesize that a high (low) crude oil-natural gas price ratio should predict a future increase (decrease) in the price of natural gas and/or a future decrease (increase) in the price of crude oil. Using the monthly composite U.S. refiner cost of crude oil (nominal dollars per barrel) and the monthly U.S. wellhead natural gas price (nominal dollars per thousand cubic feet) for January 1976 through April 2008 (388 months), we find that...

The following chart plots the crude oil-natural gas price ratio over the entire sample period. Visual inspection reveals no reversion level and no regular cycles. The range of the ratio is roughly 5 to 20....MORE