the weak tie between natural gas and oil prices
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The Weak Tie Between Natural Gas and Oil Prices. 30 th USAEE/IAEE North American Conference October 12, 2011 David Ramberg, MIT Engineering Systems Division (Co-author and Committee Member: John E. Parsons Committee Chair: Mort D. Webster). - PowerPoint PPT PresentationTRANSCRIPT
The Weak Tie Between Natural Gas and Oil Prices
30th USAEE/IAEE North American ConferenceOctober 12, 2011David Ramberg, MIT Engineering Systems Division(Co-author and Committee Member: John E. ParsonsCommittee Chair: Mort D. Webster)
2Presentation to 30th USAEE/IAEE North American Conference, October 12, 2011. Do not reproduce.
The Relationship Between Crude Oil and Natural Gas Prices
Historically, observers have noted price relationship between crude oil and natural gas. Rules of Thumb
10-to-1 Energy Content Equivalence (≈ 6-to-1) Distillate Fuel Oil Burner-Tip Parity Residual Fuel Oil Burner-Tip Parity
Cointegration (Villar and Joutz, 2006, Brown and Yücel, 2008, Hartley, Medlock, and Rosthal, 2008)
Recent discussion about “decoupling”: Temporary break from usual relationship (return later) Permanent break from old relationship and move to new one No longer any relationship at all
Which is it?
3Presentation to 30th USAEE/IAEE North American Conference, October 12, 2011. Do not reproduce.
Natural Gas and Crude Oil Spot Prices, 1991-2010 (real 2010 dollars)
4Presentation to 30th USAEE/IAEE North American Conference, October 12, 2011. Do not reproduce.
Is the Relationship Stable over Time, or has it Shifted?
5Presentation to 30th USAEE/IAEE North American Conference, October 12, 2011. Do not reproduce.
Is the Relationship Stable over Time, or has it Shifted?
6Presentation to 30th USAEE/IAEE North American Conference, October 12, 2011. Do not reproduce.
Methods to Test De-coupling Possibilities
Revisit Cointegrating Relationship:PHH,t = γ + βPWTI,t + μt (-0.0333 + 0.468 logPWTI,t + μt)
P-Value of cointegrating relationship: 0.001, R2 of full model: 0.1479 Conduct Gregory and Hansen (1996) tests using above functional
form and iteratively test for breakpoints at each observation. Apply VECM/Conditional ECM methodology from June 1997 to
identified breakpoint March 2006:logPHH,t = -1.2007 + 0.7261 logPWTI,t + μt
P-Value of cointegrating relationship: 0.0000, R2 of full model: 0.2094 Apply VECM/Conditional ECM methodology from March 2006 to
identified breakpoint February 2009:logPHH,t = 0.1969 + 0.4621 logPWTI,t + μt
P-Value of cointegrating relationship: 0.0000, R2 of full model: 0.2603 No cointegrating relationship identified between February 2009 and
December 2010
7Presentation to 30th USAEE/IAEE North American Conference, October 12, 2011. Do not reproduce.
Graphing Two Cointegrated Periods Against Actual Henry Hub Prices
$0 $20 $40 $60 $80 $100 $120 $140$0
$2
$4
$6
$8
$10
$12
$14
$16
$18
CR 6/13/97-3/10/06CR 3/17/06-2/6/09Data (6/13/97-3/10/06)Data (3/17/06-2/6/09)
WTI Price 2010$/bbl
Henr
y Hu
b Pr
ice,
201
0$/m
mB
tu
8Presentation to 30th USAEE/IAEE North American Conference, October 12, 2011. Do not reproduce.
Conclusions
Crude oil and natural gas prices in the U.S. tend to be cointegrated in the long-run, but: Volatility in natural gas prices much higher than crude oil prices.
Frequent deviations from long-run relationship Relationships gradually shifting as new technologies and policies that
govern interaction between fuels, demographic, and other demand-side factors develop
Models themselves only generally accurate at relating natural gas price levels vis-à-vis crude oil prices.
Post-February 2009 period likely indicative of relationship in flux rather than permanent severance of crude oil-natural gas pricing relationship. Due to shortage of data points to uncover a subtle relationship/lack of
much price variation, and Likely because of advent of economic methods for shale gas extraction
coming online. New equilibrium will likely develop over time.
The End
Questions?
Additional Slides
11Presentation to 30th USAEE/IAEE North American Conference, October 12, 2011. Do not reproduce.
The Mathematics Behind VECM and Conditional ECM Cointegration Models
Vector Error Correction Model (VECM):
Conditional Error Correction Model (conditional ECM):
12Presentation to 30th USAEE/IAEE North American Conference, October 12, 2011. Do not reproduce.
Methods to Test De-coupling Possibilities
Test for a co-integrating relationship: Search for a combination of the two variables of a specified functional
form that is stationary over time. After accounting for short-run divergence from this long-term relationship
and subsequent readjustment back to the long-term relationship, the remaining errors are stationary.
Persistent result is that US natural gas & oil prices have been cointegrated.
Data on seasonal, weather, and supply-related variables unavailable before June 1997
Basic cointegrating relationship from June 1997 – December 2010: logPHH,t = γ + β logPWTI,t + μt = -0.0333 + 0.468 logPWTI,t + μt
Cointegrating relationship has smaller in-sample errors than any of the rules of thumb
13Presentation to 30th USAEE/IAEE North American Conference, October 12, 2011. Do not reproduce.
Graphing Two Cointegrated Periods Against Actual Henry Hub Prices
$0 $20 $40 $60 $80 $100 $120 $140$0
$2
$4
$6
$8
$10
$12
$14
CR 6/13/97-3/10/06CR 3/17/06-2/6/09
WTI Price 2010$/bbl
Henr
y Hu
b Pr
ice,
201
0$/m
mB
tu