Oil-Gas Price Separation - 1997-2012

By Editors

Traditionally, oil and gas prices moved up and down in tandem. This was because gas was nearly always found in conjunction with oil. When a reservoir of oil becomes trapped beneath impermeable rock, some of it breaks down into natural gas. This gas creates a higher pressure, which is why oil "gushers" explode when they are first released. Once regarded as useless, the gas was generally "flared off" at the site - burned for no purpose. This still goes on in parts of the Bakken Shale today. But the construction of pipelines made this gas a valuable commodity. Since most gas is used for home heating and since it competes squarely with oil in this market.

All this has changed with the tapping of shale gas. This is the gas that, in effect, hasn't migrated to a place where become trapped beneath permeable layers of rock. Instead it is still trapped in the source rock, the shale, which is relatively impermeable.

The development of fracking as thus completely separated the availability of oil and gas. This is illustrated in the graph. The horizontal axis is the years from 1997 to 2011. The vertical axis is the price in 2010 dollars per million BTU, meaning the energy content of either oil or gas. The light brown line is the benchmark Henry Hub price of natural gas while the darker brown line benchmark West Texas Intermediate price of crude oil.

Except for brief price spikes in natural gas in 2000 and 2003, when supplies were starting to run short, the two commodities were very closely aligned until 2005, when fracking technology was introduced on a broad scale in Texas' Barnett Shale. Then a price differential opened up. Gas prices followed oil during the 2008 run-up but hardly to the same degree, with the BTU rate remaining at about half. Since 2009 the two have completely separated with crude oil climbing into the $15-20 range while gas remains below $5.

The huge differential has opened many opportunities. If natural gas could be converted to a liquid fuel - methanol, for instance - it would sell at about half the price of gasoline and help reduce our foreign imports. Or natural gas could be exported to Japan, where it sell for four times the US price, reducing our trade deficit. Either way, the huge gas-oil differential has enormous potential for improving our energy budget.

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