The Weak Tie Between Natural Gas and Oil Prices

David J. Ramberg and John E. Parsons

Working Papers from Massachusetts Institute of Technology, Center for Energy and Environmental Policy Research

Abstract: Several recent studies establish that crude oil and natural gas prices are cointegrated, so that changes in the price of oil appear to translate into changes in the price of natural gas. Yet at times in the past, and very powerfully in the last two years, many voices have noted that the two prices series appear to have “decoupled”. We explore the apparent contradiction between these two views. Although we also find that the two series are cointegrated, recognition of the statistical fact of cointegration needs to be tempered with two additional points that we think have been insufficiently emphasized in the past literature. First, there is an enormous amount of unexplained volatility in natural gas prices at short horizons. Hence, any simple formulaic relationship between the price of oil and the price of natural gas will leave a large portion of the price of natural gas unexplained. Second, the cointegrating relationship does not appear to be stable through time. Natural gas prices may be tied to oil prices, but the relationship can shift dramatically over time. Therefore, although the two price series are cointegrated, the confidence intervals for both short and long time horizons are large.

Date: 2010-11
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