Stephen Schork, author of energy industry newsletter The Schork Report, has been pondering long and hard about the subject of natural gas on Tuesday.
You see, the historic correlations appear to be a little out of whack. As Schork observes: ‘Crude oil is dear, natural gas is not… is that abnormal?’
If prices were based on thermal content alone, the usual ratio of crude oil price per barrel to natural gas in dollars per MMBtu should be ≈6:1 according to the EIA. But as Schork points out (our emphasis):
As of last Friday the ratio between spot NYMEX WTI ($/bbl) to the corresponding Henry Hub contract ($/MMBtu) was 17.3:1. In today’s Chart of the Day we posted the NYMEX ratio (adjusted per contract points). Either way, upon first glance it would appear that natural gas is a buy relative to crude oil.
But while first appearances may suggest natural gas is ‘a buy’, Schork cautions that first looks can be deceiving. For one, the relationship between crude and natural gas has certainly been acting very strangely in the last few months. As he explains:
Quantitatively, we expected a price correction to reduce crude and increase natural gas prices, but that hasn’t happened… yet. In other words, we are used to seeing a positive correlation between contracts, but crude’s run has not pulled up natural gas prices in tandem to the extent expected (most studies cited by the EIA find that natural gas prices depend upon crude oil prices, but not the reverse).
Remember, it is normal understanding (although some will argue the point) that natural gas follows crude. But as Schork points out:
The correlation co-efficient in May of 2008 was 0.833. In 2009 it’s a negative (0.101). Crude is completely failing to exert upward pressure on gas prices like it did last year.
So while crude increased from $51.12 at the start of May to $68.58 per barrel as of close on Monday, Nymex Henry Hub natural gas futures had fallen from a high of $4.690 in the first half of last month to $3.835 at last Friday’s close.
We mention last Friday’s close here as a reference point because on Monday the contract shot up 40 cents, and on Tuesday was trading at some $4.218. Perhaps some return to the correlation, but not a return that explains the recent lag. What’s more ,there’s still some way to go before the normal relationship is fully reinstated.
According to Schork if gas prices depended on nothing except crude we should really have seen an average natural gas price in May of $5.10.
Accordingly, Schork’s view is that natgas fundamentals should have been fuelling a more bullish market for some time already; technically speaking from weeks, if not months ago. Specifically prices should not have fallen from the $4.45 mid-May high. He concludes:
We’d love to root for the bulls, because it’s with them that the statistical fundamentals side. Crude is trading on fumes and late-to-the-game investors jumping on the crude oil lifeboat while the market continues to under price natural gas. As long as the equities boom lasts, look out for higher than expected summer driving season demand which could go some way to helping natural gas recover and catch up to crude.
But as prices did fall in May even despite the fundamentals and historical correlations, what we would like to know is what caused this this historic relationship to break down?
To add to the conundrum, Barclays Capital actually sees no fundamental justification for Monday’s spike higher in natural gas prices either. As they wrote on the day (our emphasis):
Today’s surge in gas prices seemed to relate more to signs that the US economy was improving than to particular gas market indicators. Positive government reports on construction and manufacturing, a solution for a major struggling US auto manufacturer, and an equity advance all likely provided upward support for prices. Cash markets were weaker across the board, with Henry Hub down by 6 cents to $3.86, SoCal Border settling lower by 11 cents to $3.19, and Transco Zone-6 losing 5 cents to $4.24.
Related links:
United States Oil Fund, redux - FT Alphaville
Commodity ETF investors move significantly into natural gas - FT Alphaville
Super-natural gas - FT Alphaville
Anything but therm in the US - FT Alphaville
