Correlation Between Crude Oil and Natural Gas Prices

Is there a strong correlation between the spot prices for natural gas and crude oil? As the chart below illustrates there would seem to be one. 

While it’s true that as the price of oil goes up, gas is soon to follow, and visa versa. However, on closer examination the prices of the two commodities are not directly linked. The US currently imports 58 percent of its oil needs versus only 16 percent of natural gas needs in 2002, making oil more sensitive to increasing international demand: think China and India. Natural gas prices are more a function of US/Canadian Supply (we get 15 percent of our natural gas from Canada) and US demand. Less than two percent of our natural gas needs are supplied by imported LNG. But now both oil and gas supplies are tight. OPEC is running flat out, Iraq's exports are down from pre-war levels, and world demand for oil continues to increase. The vast majority of our imported oil goes to run automobiles and trucks. On the natural gas side, new US domestic drilling production is not keeping up with increasing US consumption/demand.  Canada is using more natural gas itself and sending less to us and with only 4 LNG gas terminals operational there won’t be any relief via LNG for several years. It’s interesting to note that 16.4 percent of all US electrical production is generated using natural gas while 56 percent of all US homes cook and heat with natural gas. Natural gas demand rockets up from November through March each year. The peak auto driving season is during the summer months of June, July and August. The fact that both oil and gas prices are going up is a result of the fact that we (and the rest of the world) are using more of both commodities to the point where demand is closing on supply. Since one commodity is not easily substituted for the other the fact that both have been going up in price is a function of coincidental shortfalls in supply versus any direct correlation. Speculation in oil can account for some of the current record prices for oil but the US natural gas supply / demand imbalance is very real and likely to become even more pronounced. That’s one reason why we look for oil and gas drilling investment projects that have a strong gas production potential.

Comments

[Nicholas Newman]

A good clear piece, it has answered a question I had on the topic. the question is are there correlations between the price of crude oil and other forms of fuel e.g. coal.

[natural gas]

Good post.Since gas prices are largely the result of the surging price of a barrel of crude, and that is a product of speculation in the futures market, I would expect them to propose some draconian surtax (90% or so) on profits earned from the trading of energy futures...