As Crude Oil Posts New Low Below $52, What Happens to Natural Gas?

Source: 24/7 Wall St.

A strengthening dollar and uncertainty about the impact of a possible Greek exit from the eurozone weighed on crude oil trading early Monday morning. Both West Texas Intermediate (WTI) and Brent have posted new 52-week lows. WTI dropped nearly 3% to a low of around $51.20 in electronic trading, and Brent dropped more than 3% to post a low of around $54.40 on the ICE.

Natural gas, on the other hand, traded more than 4% higher Monday morning at around $3.15 per thousand cubic feet. Very cold temperatures cover the United States west of the Mississippi, and that cold weather is expected to move east in the next day or two.

While weather does drive movements in the price of natural gas, there are larger changes in effect. As recently as November, oil traded at more than 25 times the price of natural gas, and the high point came in the spring of 2012 when the price of oil was more than 50 times the price of natural gas. Last Friday, natural gas closed at $3 per thousand cubic feet and WTI crude closed at $52.69. That is just a bit above a 17 times price differential.

Before the huge spike in crude prices in the middle of the last decade, crude oil traded at about six times the price of natural gas, reflecting the actual energy equivalence of about 6,000 cubic feet of natural gas to one barrel of oil. If natural gas were the reference point, a barrel of crude would cost about $20 at today’s prices.

That is not likely ever to come to pass. What is more likely is that in the short to medium term, the price of natural gas will continue to fall as crude oil prices either drop more or stabilize at below $60 a barrel. There is one primary reason for this: crude oil producers in the United States probably will not cut production in 2015 and may not cut it in 2016.

Most crude production also results in the production of associated natural gas. Add to that more production in the Marcellus and Utica shale gas plays that will have to be redirected away from the population centers of the east coast to Louisiana’s Henry Hub, and it only makes sense that abundant supply of natural gas will keep the price in check.

Longer term, though, natural gas prices could rise as new gas-fired power plants come online and other investments that are tied to cheap natural gas prices also begin operating. As demand rises for these and for liquefied natural gas (LNG) export quantities, the differential between crude and natural gas is likely to narrow. The one thing that is very unlikely is that the crude-to-natural gas ratio will ever reach 50-times again.

Chesapeake Energy Corp. (NYSE: CHK) said in November that the company is likely to reduce production in the Marcellus region during 2015 because prices “remain challenged.” According to the Financial Times, natural gas delivered this past weekend to a pricing point in Leidy, Pa., sold for just $0.80 per thousand cubic feet. Chesapeake and other producers have hedges on some of their production to help mitigate the loss from the falling prices, but those hedges will expire eventually. That is when the going will really get tough.