The oil/natural gas ratio goes parabolic

Oil markets

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WTI v natgas Apr12.pngParabolic price movements are great fun whilst they last. The dot.com technology stock boom was a great example, when prices would jump 1% or 2% a day towards its end. And then, sadly, it all collapsed.

The NASDAQ technology index doubled in a year to reach 5000 during its final, parabolic run-up to March 2000. It then lost half its value in the next 9 months, and carried on falling until it bottomed at 1200 in July 2002.

Today, the above chart of the ratio between WTI crude oil and US natural gas prices is showing the same parabolic picture:

• Gas prices have fallen from $13.4/MMBTU in July 2009 to $2.1/MMBTU
• WTI prices have risen from $33/bbl in January 2009 to $103/bbl
• The ratio has thus almost reached 50:1

Of course, there are lots of reasons for the recent divergence in performance between natural gas and crude oil.

The dramatic rise in shale gas availability has caused gas storage problems. Users have been slow to convert from oil to take advantage of cheap gas prices. And the high-frequency traders have focused on the much larger WTI market when playing their computer games.

But fundamentally, WTI has ~6 times the energy content of natural gas. And its historical average, due to its logistic/storage advantages has been 9.9 times gas prices.

Equally, today’s sustained record oil price levels are not based on either a shortage of product, or strong demand. In fact, the reverse is true, with demand destruction taking place in all major markets.

‘Reversion to the mean’ is the most profitable investment concept. And when markets go parabolic, this is generally a good sign that the trading has become very one-sided. It then only takes a relatively minor incident to change the seemingly-unstoppable trend.

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