Gas Versus Oil: Who’s Right?

He said, she said. Two people disagree, with no other eyewitnesses, and then how do we tell who is right? There is a normal and understandable relationship between the price movements of natural gas and crude oil. Each commodity is found underground, and thus has similar costs profiles for finding it and extracting it. And each is economically sensitive, with demand rising and falling in sympathy with economic activity.

More recently, with the advent of commodity index fund management gaining popularity in hedge funds, the investment properties of each are getting more alike than they were previously and thus the price correlation has increased. Oil prices bottomed in December 2008, and have almost doubled since then as prices have recovered from the crash selloff. But natural gas prices have fallen even further, breaking the correlation in terms of the big picture, but still making minor up and down movements in sympathy with crude oil prices.

So if the two are actually related to each other, the question becomes: Who's right, natural gas or oil? Seeing disagreements like this is not new. Back in 2007, there were a couple of notable divergences when natural gas prices turned down but oil prices made higher highs. Oil turned out to be correct about the direction for both commodities in those two cases. And in late 2008, natural gas prices made a brief attempt to move up, making a higher low. But oil prices kept on heading down, eventually proving right that both oil and gas were headed lower. Now we see oil making higher prices as natural gas prices are retesting the lows just above $3.

Who's right? If history is our guide, then oil ought to turn out to be the expert about where both are heading.