Oil and Natural Gas: The Divorce is Final

Electricity and natural gas consumers are looking at declining international oil markets for signs of a break in prices.

They can keep looking. Oil prices are no longer correlated with natural gas prices. The two commodities have decoupled: Oil is a transportation fuel (with a minor role in Northeast heating oil markets) whereas natural gas is the principal fuel, after coal, for electricity generation.

Inshort:  Oil and natural gas prices are not related. There is no dirct correlation such as comes about when competing products compete against each other.

For years the two commodities moved in tandem. For example, in 2008 when international oil prices soared to $147/barrel natural gas followed and electricity markets spiked.

Today the two commodities dance to different drummers. At the molecular level, the carbon-based fuels have much in common. They react similarly to economic conditions. Energy market psychology may affect them both.

Last week oil prices dropped below $65/barrel for the first time since 2010. There are many reasons, including growing US production, – now second only to Saudi Arabia, –declining European demand, and greater efficiency of cars and trucks.

True, natural gas also dropped. But only mildly and only in response to mild December weather. Last month prices rose in response to the polar vortex. US production of gas, not oil, weighed on prices. European demand was irrelevant. Transportation efficiency was irrelevant.

A 2011 study published by MIT provides some useful perspective on now divorced commodities: http://www.mit.edu/~jparsons/publications/Weak%20Tie%20Natural%20Gas%20and%20Oil%20Prices.pdf .
True, oil price declines may be a “canary in the coal mine” for economic sentiment, presaging weaker demand for natural gas. But don’t count on it. Weather could turn natural gas prices around in a flash. And with natural gas fueling all new power generation, electricity prices would be sure to follow.