Sunday, July 1, 2012

Oil and NatGas: Rigs v. Prices

Natural gas prices have had a spectacular collapse to below $2 at least temporarily and oil is off its recent highs.  Natgas is for the time being primarily a domestic market, while oil is more global, but has still experienced recent record price disparities between domestic WTI, which has been lower versus European "Brent."  So I graphed the prices of these commodities versus their respective count of domestic drilling rigs in operation (data from --
For oil -- 

and natgas --

Both commodities have seen dramatic increases in drilling activity due to the expanded use of hydraulic fracking.  However, this increased drilling can be justified in retrospect by the price peaks seen in both commodities in the past decade.  The increased drilling activity in oil has been more recent and more pronounced than that for natgas.  Natgas experienced its first price and drilling peak in Y2K, with the price going from $2/mcf to $10, a smaller peak in 2003, and the most dramatic -- up to $13 --  in two peaks in 2005 and 2008.  Nat gas is famous for its price volatility (its futures market being nicknamed the widowmaker) owing to the obvious difficulty of storage.  However, oil has seen an equal jump in price over the last decade, going from $30 to as high as $140, but only in two peaks versus 4-5 for natgas.  While natgas has seen drilling activity decline in the face of soft prices, oil has yet to see a similar price-induced fall in the rig count.  While oil prices have presumably been supported by unprecedented and sustained demand from developing economies such as China and India, some fear that the bloom is off that rose and there is even suspicion that China's growth may have been dramatically overstimulated by reckless speculation and statistical forgery.  We shall see.  Longer term the natgas market is theorized to experience dramatically increased demand from international LNG shipments, while for oil the Brent/WTI spread may be diminished by a pipeline from the central storage area in Oklahoma to the ports on the Gulf Coast.  A more near term price spike may be in the making for natgas with the dramatic decline in drilling and a wholesale shift by electric utilities to that commodity and away from coal as a generating fuel.  The demand for natgas as a power generation fuel is supported (in addition to low prices) by the failure of engineering efforts to make "clean coal" a practical reality, with air pollution (sulfur and CO2) and coal ash continuing problems, not to mention mining hazards and increasing resistance to mountaintop removal.  From an investment standpoint, it is probably worth it to get some exposure to natgas now and wait for a further possible drop in the price of oil.

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