Oil prices have ticked up recently on the strength of high demand and speculations about shrinking supply. Commodity prices have increased more than 20% from their August 3rd low, signaling the beginning of a bull market. This is good news for investors in the energy sector, though those investors may be disappointed with the performance of a parallel commodity: natural gas.
Because they’re used in similar functions, many experts expect the price of natural gas to track closely with the price of oil. This year, that has not been the case. Natural gas prices lag oil prices by roughly 10% to date.
There are three key reasons why natural gas hasn’t performed to expectations on the year: fears of over-supply, soft exports, and refinery bottlenecking.
Like oil, the supply of natural gas has remained robust over the past year. Hydraulic fracture (fracking) technology continues to improve, as the collection of natural gas from deep wells becomes both more efficient and safer. While this is good news for the long-term health of the industry, the ease of capture also tends to produce greater and greater supply. All else being equal, this increased supply has a depressive force on prices.
One of the forces driving up the price of oil is speculation that OPEC will soon freeze production levels. Key OPEC officials announced a meeting to occur alongside an energy conference in Algeria. Investor action indicates the common belief is that this meeting will be used to announce a reduction in production after nearly a year of consistent increases. This production freeze will decrease available supply. Investors are likely trying to get out ahead of this supply decrease by buying oil futures contracts. This speculation is driving up the price of oil, but doing nothing for demand for natural gas.
The export market for natural gas has also hurt the export market. As the price of oil has been low all summer, foreign markets have been glutted with cheap petroleum. This has sopped up typical summer demand for natural gas for cooling. This weakness in the export market is most visible in the proportion of rig construction devoted to natural gas, which has declined sharply over the past 6 months.
There is also a bottleneck in the refining process for natural gas. Production increases in natural gas have typically followed production increases in oil. While the refining infrastructure for oil is well developed and growing, natural gas has not kept pace. There are still relatively few companies involved in the refinement of natural gas. Fewer companies are competing for the unrefined product, resulting in generally lower commodity prices.
It’s also worth remembering that the gains in the oil market are fueled by speculation and could be temporary. If OPEC doesn’t cap production, prices will likely fall again, and rapidly. Investors should be cautious with any commodity investment.