Relationship Between Crude Oil And Natural Gas Prices Essay

Relationship Between Crude Oil And Natural Gas Prices - Essay Example Observing the pattern of crude oil and natural gas prices generally supports the economic theory and leads to the belief that both commodities do share a relationship. However, over the past few years, a decoupling of natural gas prices from crude oil prices has been observed (refer to graph 1.1 in appendix). This has led concerns over the strength of the relationship between crude and natural gas prices. Economic factors link crude oil and natural gas prices through supply and demand. There has been a strong conviction regarding the one-way relationship between the prices of crude oil and natural gas, whereby changes in crude figures influence natural gas prices and any changes in natural gas prices have no impact on crude. This is due to the relative size of each market. Prices of crude are determined on the world market whereas natural gas valuation takes place in regionally segmented markets. As a result, any adverse event or condition is unlikely to affect the global price of oil (Villar, Joutz) This paper attempts to signify the economic and statistical relationship between crude oil and natural gas prices. The period under review is from 1985 to 2005. ... Overview of Natural Gas Industry The structure of the natural gas industry has changed dramatically over the last 15 years. In the past, the structure of this industry was simple, with limited flexibility and few options for gas delivery. Exploration and production companies explored and drilled for natural gas, selling the product to transportation pipelines. These pipelines transported the natural gas, selling it to local distribution utilities, who in turn sold the product to its customers. Pricing at the exploration, production and transportation level was federally regulated whereas state regulation monitored the price at which local distribution companies sold natural gas to customers (naturalgas.org). Prior to deregulation, the structure of the natural gas industry was very straightforward, however, it suffered from shortages in the 1970s and surpluses in the 1980s. Since deregulation, the industry is much more open to competition and choice. Prices are no longer regulated and are determined by the demand-supply forces. One of the notable differences in the revised structure of the natural gas industry is the existence of natural gas marketers. They serve to facilitate the movement of natural gas from the producers to the end users. Marketers may either own the natural gas being transferred, or simply act as facilitators for the transportation. Source : NGSA The diagram above shows the pathway of natural gas from producer to end user in a regulated environment. The diagram below shows the pathway in a deregulated environment where marketers exist and can sell directly to end users. Source : NGSA Price of natural gas is simply a function of demand and supply. When demand for gas rises,