by Kevin Klombies, Senior Analyst

Friday, August 29, 2008

Chart Presentation: Crude Oil/Natural Gas

Crude oil futures prices declined more than 2 points yesterday back into the 115’s even as Tropical Storm/Hurricane Gustav took direct aim at the heart of the Gulf of Mexico’s oil production. When most would assume that oil prices would have to rise astraders short crude oil futures rushed to cover positions in front of a 3-day weekend… oil prices actually declined.

We will argue that oil prices fell for two basic reasons. First, the International Energy Agency stated that it would release energy stockpiles if production was impacted by Gustav. Second, natural gas inventories showed a sharp build which led to roughly a 6% decline in gas futures prices. Of the two we will suggest that the latter is likely the more important.

The chart below shows the ratio between crude oil and natural gas futures prices from the end of 1992 up through yesterday’s trading. In general the ratio tends to hold between a low of around 4:1 and a high close to 14:1.

At present the ratio is hovering in the stratosphere as it holds just above 14:1. In other words oil prices are already so ‘high’ relative to natural gas prices that it is very difficult to get stronger oil prices on a day when natural gas prices are weaker.

The chart below includes the crude oil/natural gas priceratio along with crude oil futures prices from the second half of 1998 through into the spring of 2002.

There isn’t a particular reason why we chose this time frame other than it included two fairly major bottoms for crude oil futures prices. The argument- one that we made in passing earlier this week- is that at significant lows for crude oil futures prices the ratio will tend to be somewhere between 5:5:1 and 7:1. Put another way a ratio below 7:1 will not always mark a bottom for crude oil prices but it is unlikely that a bottom for crude oil prices will be made until the ratio declines below 7:1.

To put this into some form of perspective if natural gas futures remain near, say, 8 then crude oil futures prices would have be decline BELOW 56 before a meaningful bottom would be put in. Given that 56 is close to 50% below the recent lows for crude oil we will argue that the decline in oil prices this quarter has so far been little more than a drop in the bucket.