Ruminations on the Gas and Oil price and Ouija boards

Aweh dearly beloved fellow ruminants & groupies in day 729 of re-modified lockdown Level 1.

Period as a semi-retired pensioner: 357 days

Today I can announce that my days as a semi-retired pensioner are about to come to an end.  Starting in April I will be joining the African Energy Leadership Centre (AELC) at the Wits Business School as an academic. I started my career in the eighties as an academic then I spent 3 decades in the petrochemical industry before returning to my roots and my alma mater. This will hopefully provide a fitting last chapter to my career before I retire again. Hopefully, my blog will continue but perhaps there will be even more bloviating and pontificating about energy than before because I can.

Last week I wrote about the oil price and the expensive consultants and the forecasting departments within large corporates with their Ouija boards who forecast the oil price and tell management what they want to hear for a very reasonable fee. The inconvenient fact that the forecasts have no predictive power and are unscientific is no deterrent to their persistence. This week I would like to extend the discussion to gas prices.

Well-organised corporates often have well-defined job descriptions, and the officially sanctioned Ouija board department doesn’t always take kindly to those who may sometimes swim outside of their lane. Now I may swim where I please.

Last week’s blog emphasised how volatile and unpredictable oil prices are. This week we will add in the even more volatile and unpredictable gas prices into the mix. The featured graph will be used for discussion. The link between oil and gas prices has been explored in the very interesting, if slightly out of date, paper referenced here. http://www.mit.edu/~jparsons/publications/Weak%20Tie%20Natural%20Gas%20and%20Oil%20Prices.pdf. For the nerdy geeks amongst my readers, this is worth looking at.

The featured graph plots monthly West Texas Intermediate (WTI) and Henry Hub gas prices sourced from EIA from 1997 to the present. The main use of both oil and gas is as a source of energy or as an energy carrier. If you as an energy user had a device where you could choose whether to use oil or gas depending on which was cheaper what would you do?

What is the structure of the relationship of the natural gas price with the oil price? It seems natural to imagine that the price of oil and the price of natural gas would tend to rise or fall in tandem. They are both energy carriers, with one barrel (bbl) of crude oil having approximately the same energy content as six million Btu (mmBtu) of natural gas. This rough logic would argue that the price of a barrel of crude oil should equal six times the price of a mmBtu of natural gas. If the price of natural gas rises by $1/mmBtu, then the price of crude oil should rise by $6/bbl. This is the energy parity line shown on the graph.

Above the line, gas is expensive relative to oil and below the line the reverse is true.  By this measure, most of the time gas is cheaper than oil in the USA. One can also see that both gas and oil prices are very volatile sometimes with big changes from month to month. In addition, oil and gas prices do not always move in tandem, particularly in the short term.

 Historical analyses of the time series indicate that US oil and gas prices are co-integrated (co-integration is a mathematical term) http://www.eco.uc3m.es/~jgonzalo/teaching/EconometriaII/cointegration.htm relating to time series which can loosely be interpreted in layman’s terms as correlated in terms of the simple English meaning of the word correlated. There is however a lot of volatility in both oil and gas prices. Gas prices are very volatile and are subject to exogenous factors such as the weather, storage levels, Russian military aggression etc. The authors in the referenced paper go into all of this.

The analogy provided in the link on cointegration is very useful. Imagine a drunk staggering home from the bar on a Friday night with his hyperactive dog. The (male) dog is on one of those leads with a (very) long cord whose length can be adjusted by the drunk. The drunk makes very inefficient progress to his house with many random detours and staggers from left to right in an unpredictable fashion. The dog has his own agenda and needs to mark his territory on every fire hydrant and check every dustbin for food (exogenous factors). From time to time the drunk gets frustrated with the dog and shortens the leash but then feels sorry for the dog and lengthens it again. The path of the dog and the drunk will be co-integrated. When the leash is short the co-integration will be strong but when the leash is (very) long some would argue that the dog and the drunk are decoupled.

The two fuels have different costs of production, transportation, processing, and storage, and they serve different portfolios of end uses with only a modest overlap. There is more established infrastructure to move crude oil around the globe and it is much cheaper to move crude and liquid fuel than gas. Crude oil can be moved via tanker and pipeline to inland South Africa from Saudi Arabia for 2-3$/bbl. Gas is much more difficult and costly to transport and there is less existing infrastructure. The recent crisis unfolding in Europe with regards to Russian pipeline gas is illustrating this point. There is a global oil price, but gas prices are still regional. Our house in Johannesburg uses Egoli gas which is piped from Mozambique, and I have plotted the price on the graph. Compared to Henry Hub pricing it is very expensive. Consumption of gas in South Africa is relatively small and the infrastructural costs are high. The gas suppliers are also not communists and profits are being made.

The Russian crisis is likely to significantly accelerate the investment into more gas infrastructure in Europe and further growth in the global liquified natural gas (LNG) industry in Europe and globally is likely.  This is notwithstanding the fact that gas is a fossil fuel. If carbon taxes increase one should also expect gas prices to rise relative to oil as it has a better CO₂ footprint than oil and coal.

Although the end-use overlap between oil and gas is limited there are some technology options to arbitrage between oil and gas. In the USA gas has tended to be cheaper than oil and the late eccentric oil baron and billionaire T Boone Pickens hatched the “Pickens Plan” to convert long haul trucks to LNG or compressed natural gas in 2008. https://en.wikipedia.org/wiki/Pickens_Plan.  When oil prices declined this fell by the wayside.

Gas to liquids (GTL) technology using either Fischer Tropsch or methanol technology is another option. Both technologies have an energy efficiency of about 60% and the feedstock cost is plotted on the graph. Above the line, a GTL process would be cash negative and no allowance has been made for the capital reward which would shift the line downwards. Looking at this would you invest in GTL technology in the USA? I would suggest that you would only consider this if you were using government money or failing that shareholders money, certainly don’t use your own money. The Ouija board department was not amused by this message. What do I know anyway, remember to stay in your lane and my credentials are suspect? There are those who know much better than me. Extremely well-paid management consultants with much more impressive CVs than mine did not agree. Indeed.

So, what about the import of LNG into South Africa? Although there are those who believe South Africa should progress straight to renewable energy and aggressively phase out coal and gas this is not likely to be feasible or affordable in the medium term. LNG import into South Africa is most likely required but it will also not be cheap, and you can add $4-6/MMBTU to Henry Hub prices to get gas from the USA (or elsewhere) to inland South Africa. Given the extreme volatility of gas prices don’t expect predictability in gas prices prices unless you have a Ouija board.

 Thank you very much for your comments and suggestions and please keep them coming.

Regards

Bruce