1. OIL AND NATURAL GAS PRICES: TOGETHER AGAIN?
Prakash Loungani (IMF) Akito Matsumoto (IMF)

2. Oil and Natural Gas Prices in the U.S.

3. What happened?
The two prices co-moved (were cointegrated) through 2009.
The relationship breaks down with addition of recent data.
This is probably due to shocks to natural gas prices than to crude oil prices.
We show this quantitatively, and document background. Moreover, we conjecture that the prices will co-move again in the future.

4. In broader context,
This is an example of the breakdown of the law of one price in the face of technological progress.
The reason behind this is real rather than nominal rigidity.
Natural gas is tradable and the U.S. has been importing and exporting some.
The U.S. does not have large enough capacity to export natural gas

5. Motivation Shale gas revolution. What is the impact?
This paper answers questions about the price impact of the shale gas revolution.
It’s the first step to understanding the impact on various economic issues, e.g., global imbalances, employment, growth and technology.

6. What we do?
Cointegration tests on the variables of interest, such as the natural gas price in the U.S. and the crude oil price in the U.S.,
Also unit root tests on the relative prices, e.g., the natural gas price to the crude oil price.
These tests provides some evidence regarding the link between two variables.
Changing sample periods sheds lights on the changes in relationships.

7. Quick literature review
Natural gas price and crude oil price
Confirming cointegration between the two
Brown and Yucel (2008); Hartley, Medlock and Rosthal (2007);
Indicating weaker tie
Ramberg and Parsons (2012) and De Bock and Gijón (2011)

8. Crude oil and natural gas prices
They are close substitutes. As energy sources, they are linked by the burner tip parity. How much energy you can get?
Brown and Yucel (2008) say that one barrel of oil contains the energy equivalent of the million BTU of natural gas. However, this relation overstates the price of natural gas.

9. Price Part Natural gas price in the U.S. ← →
Natural gas price in Germany ↑ ↗ ↓ ↙
Crude oil price in the U.S.
Crude oil price in Germany
Rejection of unit root (or null of no cointegration) in most cases for most sample periods.
PP, ADF, DF-GLS(ERS) as well as cointegration test
However, natural gas price and crude oil price in the U.S. is not cointegrated any more (i.e. fail to reject null of no cointegation and null of unit root). The same for law of one price for natural gas.

10. Unit Root Tests Relative Price (in the U.S)
Natural Gas: Law of One Price
Sample Start
1993m1-
Sample End
2005m12
2009m12
2014m6
2015m12
Phillips Perron (1988)
(Critical Value, 1% -3.43; 5% -2.86;10 %-2.57) Zt
-3.79
-3.72
-2.06
-2.22
p-value (Zt) 0%
26%
20%
Z(rho)
-26.8
-27.5
-9.3
-9.8
AR Coeffcient
0.82
0.87
0.96
h* (months)
3.4
4.8
15.9
15.2
ADF
Lag (SIC) 1
-3.91
-3.89
-2.35
-2.59
16% 9%
3.6
4.9
15.7
15.0
ha (months)
3.2
4.4
14.3
Lag (AIC) 22
-0.08
-0.77
95%
83%
+INF
372.9
45.5
1993m1-
2005m12
2009m12
2014m6
2015m12
Phillips Perron (1988)
(Critical Value, 1% -3.43; 5% -2.86;10 %-2.57) Zt
-3.15
-2.96
-2.11
-1.90
p-value (Zt) 2% 4%
24%
33%
Z(rho)
-19.7
-17.8
-9.1
-8.0
AR Coeffcient
0.87
0.91
0.96
0.97
h* (months)
5.0
7.5
18.0
20.9
ADF
Lag (SIC) 1
-3.28
-3.04
-2.28
-2.10 3%
18%
5.1
7.6
17.8
20.6
ha (months)
4.6
7.1
17.1
19.9
Lag (AIC) 3 22
-2.65
-1.96
-0.90 8%
31%
79%
8.1
19.4
25.0
7.8
19.7
42.5

11. Unit Root Tests (2) Relative Price (in Germany) Crude Oil: LOP 1993m1-
2005m12
2009m12
2014m6
2015m12
Phillips Perron (1988) Zt
-3.11
-3.94
-3.61
-4.04
p-value (Zt) 3% 0% 1%
Z(rho)
-18.9
-30.9
-27.7
-32.6
AR Coeffcient
0.91
0.94
0.93
h* (months)
7.1
7.7
10.7
9.0
ADF
Lag (SIC) 2 3
-3.23
-4.83
-4.28
-4.84 2%
6.5
5.1
7.3
6.4
ha (months)
5.8
4.7
6.7
5.9
Lag (AIC) 12 14
-4.41
-4.97
-2.90
-3.51 5% NA
7.2
2.8
2.6
6.8
1993m1-
2005m12
2009m12
2014m6
2015m12
Phillips Perron (1988) Zt
-6.37
-5.76
-4.85
-4.52
p-value (Zt) 0%
Z(rho)
-66.1
-57.8
-42.6
-38.6
AR Coeffcient
0.59
0.71
0.81
0.83
h* (months)
1.3
2.0
3.3
3.7
ADF
Lag (SIC) 2 3
-4.76
-4.97
-4.28
-4.19
1.8
2.5
3.9
4.3
ha (months)
1.7
2.2
4.2
Lag (AIC) 1 6
-4.48
-2.58
-2.32
10%
16%
1.9
1.6
5.9
7.1

12. Natural gas price in the U.S. ← → Natural gas price in Germany ↑ ↗ ↓ ↙
Crude oil price in the U.S.
Crude oil price in Germany
Up to 2009
Up to Now
Natural gas price in the U.S. ← →
Natural gas price in Germany ↑ ↗ ↓ ↙
Crude oil price in the U.S.
Crude oil price in Germany

13. Why Decoupling? Shale Gas!

14. We need deeper analysis.
But that’s too simple.
What about energy parity?
Does natural gas decrease energy content? NO! Then, why not switch?
What about the law of one price? Why not trade?
Indeed, the U.S. is importing and exporting natural gas.
Then, why decoupling?
We need deeper analysis.

15. Production and consumption
They have been cointegrated up to And excess supply, defined as the log difference of production and consumption, has been stationary. Now they are not cointegrated or stationary.
Production beyond the usual energy substitution capacity. Some electric power companies have started to use natural gas but not enough.

16. Unit Root Tests (Excess Supply)
Sample Start
1993m1-
Sample End
2005m12
2009m12
2014m6
2015m12
Phillips Perron (1988)
(Critical Value, 1% -3.43; 5% -2.86;10 %-2.57) Zt
-2.76
-2.39
-1.27
-0.13
p-value (Zt) 6%
14%
64%
95%
Z(rho)
-26.8
-27.5
-9.3
-9.8
AR Coeffcient
0.82
0.87
0.96
h* (months)
3.4
4.8
15.9
15.2
ADF
Lag (SIC) 2
-3.42
-2.87
-1.61
-0.39 1% 5%
48%
91%
9.4
13.9
62.1
287.1
11%
56%
89%
99%
Lag (AIC) 16 13 14
-2.53
-1.46
-0.49
0.60
5.9
21.8
210.6
+INF
ha (months)
8.5
20.3
198.5

17. Production and Consumption

18. For now, gas is stored.

19. Excess supply and relative price
Excess supply and relative prices are cointegrated in the full sample. (They are individually stationary up to 2009.)
The cointegration relation indicates positive excess supply dampens the natural gas price relative to the crude oil price.
It also indicates that even now if excess supply diminishes relative price should be in line with the past level.

20. Cointegration Excess Supply and Relative Prices
Sample Start
1993m1-
Sample End
2005m12
2009m12
2014m6
2015m12
Lag 2 3
Critical Value 5% 1%
Trace Test
H0:r=0;Ha:r>0
15.41
20.04
28.23
29.02
30.16
20.50
H0:r=1;Ha:r>1
3.76
6.65
11.88
8.28
2.85
0.64
Maximum Eigenvalue Test
H0:r=0;Ha:r=1
14.07
18.63
16.34
20.73
27.31
19.86
H0:r=1;Ha:r=2
# of cointegration chosen by
1% trace test NA 1
5% trace test
Cointegration Vector (Relative Price=1)
Excess Supply
-0.71
3.81
4.66
3.35
[standard error]
[1.67]
[1.39]
[0.52]
[0.60]

21. Why not export?
The U.S. has been importing natural gas. Import volume has been shrinking. LNG is almost 15% of its peak volume. So some adjustment.
Large part of import is pipeline import from Canada and it is cheap.
Then, why don’t both the U.S. and Canada export to other countries? Law of one price is violated, and natural gas is more expensive in Europe (and Asia as well.)

22. U.S. Natural Gas Imports (Tcf)

23. It is hard to export natural gas
Canada and the U.S. both need to export. Then, it has to be LNG unless Mexico absorbs a lot.
The U.S. has import facilities. That is liquid to gas. But it did not have exporting facilities until recently. (Chenier started LNG export this year)
Canada has started a few projects. But these projects will start construction a few years hence and export probably 10 years after that.

24. So what will happen? Energy substitution will probably occur slowly.
Some network problem, e.g., natural gas vehicles and natural gas stations, might need government intervention.
The U.S. is expected to be a net exporter of natural gas around Heading to recovery of law of one price.
Or shale gas revolution fails and natural gas price goes back.
In any case, relative price will probably converge back.

25. Conclusion
We find that the natural gas price in the U.S. has decoupled with the crude oil price and the natural gas price in Germany.
This decoupling is in line with excess supply given that relative price is cointegrated with it.
We conjecture this is “temporary” but a significant enough change that it breaks down the existing links (cointegration, law of one price.)