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Oil to natural gas ratio
A new “normal” of 3x the old, in the US
We see at least three more years of a very large opportunity
Oil and natural gas prices have historically traded in a tight correlation. For long
stretches of time, prices of oil in US$ per barrel would converge on a ratio of 6 to 1
relative to prices of natural gas, in US$ per million British thermal units. That ratio
approximates their heat-value equivalent. Then the ratio began to shift closer to 8 to
1. Of course, the oil to gas ratio would move out of its customary range (between1:6
and 1:8) at times -- but not usually very far out of line, nor for very long.
In 2009 the gas to oil relationship broke down fundamentally.
Oil traded at 12.8 times the price of gas in 2009 and that premium widened to 17.9
times this year. This is just the beginning. We forecast that the ratio of oil to natural
gas will widen still more next year and should stay at roughly three times the heatequivalent
price of US natural gas through 2013, or longer.
Oil strength builds, as America’s natural gas glut grows
Oil fundamentals are strengthening, as is confidence behind our medium-term
thesis: We observe that widespread global oil demand growth has resurfaced. And
we forecast that before too long supply will again struggle to keep up with demand.
We see oil price trends rising through 2013, and probably beyond (see also our
latest note: Oil prices and fundamentals: Bridging the data and price gap” 24
November 2010). Conversely, in North America at least, enough new sources of
natural gas supply have been proved that any upstream risk has effectively
dissipated. And until demand grows dramatically a structural surplus appears locked
in place for years. We are bearish US natural gas through 2012, at least.
Whetting the appetite of the US chemicals sector
Cheap gas and expensive oil spells a massive opportunity for North America‟s
chemicals sector. Chemical plants here mostly use natural gas as feedstock, while
most of the sector‟s international competitors use either oil or gas priced to oil. Not
coincidentally our colleague Cooley May initiated with a broadly positive view on five
chemicals companies earlier this week in a report titled “US Chemicals: A dish
served hot with appeal” 29 November 2010.
Other sectors could benefit too – think gas to liquids, for instance.
Risks yes, but with long lead-times
Risks of the oil to gas price ratio converging to nearer historic norms remain. But to
change the fundamentals of either oil or natural gas structurally will take time.
In the shorter term, it‟s difficult to see how gas prices would rise much above US$5-6
mBtu, or for oil prices to fall below US$70/b.
And at those extremes, near-term downside risk for our ratio is limited at 12 to 1, or
double the heat value of oil to gas.
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