Will Crude Head Lower?

Record Oil-Gas Price Ratio May Be Set to Narrow: Chart of Day

 

By David Wilson

Aug. 25 (Bloomberg) -- Crude oil has become so expensive compared with natural gas that the record price ratio between them probably won't last, analysts say.

The CHART OF THE DAY shows the prices of these commodities since 1990, when natural-gas futures started trading on the New York Mercantile Exchange, in the top panel. The ratio between them, which closed at a record 26.4-to-1 last week, appears in the bottom panel.

The ratio has more than tripled this year amid a 67 percent increase in crude prices, bolstered by speculation that Chinese demand will climb. Gas prices have fallen 48 percent on reduced demand from industrial companies and the start of production at new U.S. fields.

"History clearly suggests that the price gap will eventually narrow, through some combination of oil prices falling and natural-gas prices rising," Donald Marron, a former member of the Council of Economic Advisers, wrote in an Aug. 21 posting on his blog.

The timing of any return to historical norms, also known as mean reversion, is questionable. Marron didn't speculate in his posting about when that might take place.

"Who knows when we'll see some reversion to the mean," analysts at Bespoke Investment Group wrote yesterday in a comment highlighting the oil-gas ratio.

Comments:

Like many commodities, crude oil has substitutes and near-substitutes. The dramatic widening of the crude oil to natural gas ratio shows how out of whack the price of crude is compared to fundamentals. Global consumption has fallen and production has fallen to a lesser extent, yet prices remain high. The Oil to Gas ratio averages approximately 10 to 1. A return to that level would imply a drop in crude prices to the $30 per barrel range.

Looking at Fibonacci levels alone leads one to conclude that $40 crude is not out of the question. We note that despite US dollar weakness, crude has failed to break through even the 38.2% Fib level of $78. The next critical point is the 23.6% level of $60. If this fails to hold, crude in the $40 range or lower becomes a real possibility.

In an earlier post in July, we considered the possibility of a drop in crude prices and the TSX. To view that post click here http://whatisthatwhistlingsound.blogspot.com/2009/07/where-are-tsx-and-crude-oil-headed.html.