Cleantech Market Intelligence
Reading the Oil and Natural Gas Ratio Tea Leaves
One of the key energy trends that Pike Research has been tracking over the last few years is the rising volatility in the oil-gas price ratio. Measuring the difference between the price of a barrel of oil and an mmBtu of natural gas, the oil-gas ratio has held relatively constant over the last 25 years, with oil trading at 8 to 10 times the price of natural gas. While a barrel of oil’s relative energy density to an mmBtu of gas suggests that the ratio should really be about 6 to 1, oil trades at a premium due to global demand and its relative convenience as an energy carrier.
Beginning in 2009, that historical correlation started to disintegrate in the United States, due mostly to a combination of rising global crude prices in response to Middle East and North African geopolitical events and a surge in domestic production from unconventional shale gas.
As illustrated by the chart below, the ratio has reached 50 to 1 in recent months (touching as high as 52 to 1 in April 2012), more than five times the historical average:
As energy commodities, crude oil and natural gas should logically have a high degree of correlation. In reality, key market differences translate into diverging drivers. On one hand, oil is a global commodity with macro-level demand drivers, and its price is acutely sensitive to above-ground, geopolitical forces. Natural gas, on the other, is closely tied to regional markets with prices primarily driven by local forces.
The divergence is significant on many levels, but at the heart of this shift is a fundamental imbalance in energy markets that has yet to run its course.
Writing for the Wall Street Journal, Carolyn Cui explains:
“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 and switch. That may eventually narrow the gap again, but it could be a costly and time-consuming process.”
For clean energy, volatility in the oil-gas ratio points to a substantial shift in market dynamics, which even if short-lived, will have substantial implications for cleantech growth over the coming decade.
Consider that one of the key drivers behind the growth in the clean energy sector in recent years was a purported shortage of fossil fuels, specifically oil and gas. Facing the prospect of Peak Oil and predicted natural gas shortages across the United States just five years ago, stimulus dollars and public policy coalesced around clean energy. With a scarcity-propelled rise in fossil fuel prices and innovation across the clean energy landscape driving down costs, price parity for grid, fuel, and other applications seemed just around the corner.
While parity can be fleeting, it has been achieved in some applications; in others, a precipitous drop in natural gas prices across North America has raised significant barriers for still growing industries like landfill gas-to-energy (LFGTE), solar, and geothermal, that remain relatively expensive. As depicted by the sharp increase in the oil-gas ratio, this shift happened almost overnight, and in some instances, caught investors and project developers completely by surprise. In other applications, such as the use of LNG fuels in place of diesel for captive fleets, lower natural gas prices could actually benefit clean technologies such as biomethane production.
Although the ratio has fallen in recent months, it remains unclear whether a return to the status quo will lead to business as usual or a more permanent diversion will result in a significant paradigm shift. Some experts argue that current volatility is only a short-term anomaly and that forces will act to bring prices back into their long run equilibrium, while others question whether or not a stable long run relationship between crude oil prices and natural gas prices even existed in the first place.
Amid the uncertainty, many project developers appear to be taking a wait-and-see approach, especially U.S. policy will coalesce behind natural gas away from the traditional fossil juggernauts, coal and oil. In the first case, unfolding regulations from the EPA targeting coal plants suggest that this shift may be underway; in the latter, time will tell.
While my colleagues Dr. Kerry-Ann Adamson and Dexter Gauntlett and I have examined the natural gas phenomena and its impact on Smart Energy (see Natural Gas – Boon or Bane for Smart Energy?) as well as biogas (see Biogas and the Natural Gas Bonanza), the widening gap between relative prices is certainly worth monitoring. As Boon or Bane points out, however, it may still be too early to tell which technologies stand to benefit and which may suffer.