By CAROLYN CUI
Oil and gas, once involved in a stable relationship, continue to grow further apart.
During the first quarter, the price gap between crude oil and natural gas widened to an extreme, as oil prices were buoyed by supply concerns amid Middle East tension while gas prices were weighed down by an usually warm winter and a supply glut in the U.S.
Historically, the relationship has been steady, with a barrel of oil trading about 11 times the price of a million British thermal units of natural gas since 1990, when gas started trading at the New York Mercantile Exchange. The oil-to-gas ratio started to climb in 2009 as a result of large discoveries of shale gas, and on March 27 reached an all-time high of 48.6 times.
The huge gap points to a fundamental imbalance in energy markets. Customers who burn cheap U.S. natural gas as a fuel currently enjoy a competitive advantage, and buyers of other fuels have a rising incentive to try to switch. That may eventually narrow the gap again, but it could be a costly and time-consuming process.
For the quarter, natural gas tumbled 28.9% to $2.1260 per million BTUs, the lowest since February 2002. Meanwhile, crude oil added 4.2% to $103.02 per barrel at the Nymex.
The divergence of crude oil and natural gas hasn't gone unnoticed among many commodities investors, who have been betting on the price ratio to head back toward historical norms. Investors put $173 million in net cash into exchange-traded products linked to natural gas in the quarter as of March 23, according to Deutsche Bank Securities Inc.
"Given the recent price drop [in natural gas], people might think this is a good entry point," said Shan Lan, head of global equity index and ETF research at Deutsche Bank.
However, Mother Nature wreaked havoc on that strategy. The winter just passed was the fourth warmest since 1896 in the U.S., according to the National Climatic Data Center. The winter was 15% warmer than normal based on the number of heating-degree days, according to National Grid; heating-degree days is a measurement designed to reflect the demand for energy needed to heat a building.
"Even a 1% change is significant," said Shawn Reynolds, a portfolio manager of Van Eck Global Hard Assets Fund, a $4.4 billion fund focused on commodities, estimating that weaker heating demand had reduced natural-gas use by about 2% to 3%.
Throughout the quarter, crude-oil prices showed resilience amid escalating tensions between the West and Iran over Tehran's nuclear program. Prices had soared in February as major oil-consuming countries, such as Japan and South Korea, reduced imports from Iran ahead of a planned oil embargo.
The surge lost some steam toward the quarter's end as high prices started to damp demand. Still, Brent crude ended the quarter at $122.88 per barrel, up 14.4%.
Natural gas also was a victim of oversupply, with production up 9% year to date, according to Chris McGill, a managing director at the American Gas Association. The blame in part goes to the growing interest in oil drilling, as more gas was found as a byproduct in oil-rich fields.
"The normal feedback loop that reduces gas production is being blocked by the high price of crude oil," said Walter Zimmermann, vice president of United-ICAP, an advisory firm for the energy industry. "The more they drill for crude to take advantage of the higher price of crude, they more gas they get, that further depresses the gas price."
During the first quarter, several major shale-gas drillers reduced production.
Still, the jury is still out on whether these moves are enough to balance an oversupplied gas market. "We are not seeing as much a reduction as anticipated," said Mike Corley, president of Mercatus Energy Advisors LLC, a Houston-based energy advisory firm. "This is the first time that natural-gas prices have stayed depressed for such a long period of time."
So, what will bring down the oil-to-gas ratio in the near term? Lower oil prices may do the trick. Analysts noted that a host of bearish catalysts were emerging for oil: Higher energy prices are starting to take a toll on demand, the U.S. and its European allies are considering tapping into strategic reserves to stem the soaring prices of gasoline at the pump and the fear over a supply disruption in Iran could fade away.
"If [oil] prices are going to fall, the time is now," Morgan Stanley MS -0.51%analysts wrote in a paper on March 26.
