The price ratio between oil and natural gas has risen to unprecedented heights, far out of its normal range, as this graph from Bloomberg Business Week indicates. The premium of oil over natural gas now stands at 50 percent higher after never being more than around 10 percent higher over the last two decades.
The green shaded area represents oil's premium over gas from May 1990 to May 2012 (the horizontal axis). Historically, oil has been priced about 10 percent above natural gas in terms of energy value. This is because, although natural gas has many valuable uses, oil is essentially irreplaceable in running automobiles. Even when oil prices hit $123 a barrel in 2008, oil and gas prices moved in tandem. This was because their supply curves were essentially identical. Gas was usually found in connection with oil and matched its production.
Since the introduction of hydrological fracking, however, gas has become a separate commodity and supplies have gushed forth. Prices have fallen from a range of $6 per thousand cubic feet to below $2. Meanwhile oil has not seen the same upsurge in production and prices have recently pushed to the $100 a barrel range, although they have now come down slightly. All this has completely changed the oil-gas ratio, as the graph indicates. In the last year, oil spiked form 20 percent above gas prices to nearly 50 percent.
Will the equilibrium between oil and gas prices ever re-establish itself? It is indeed possible. The liquefaction of natural gas may turn it into a commodity that transports more like oil. The use of natural gas in cars, either as compressed natural gas or methanol, will once again make the two fuels more interchangeable. The cutbacks in natural gas drilling and new concentration on shale oil fields may even out supplies. Although not identical, the two commodities are closely linked and at some point they will probably again become more interchangeable.