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1 Dec 16 2009 @ 9:00am by Matt Smith in Crude Oil, Natural Gas

Oil/Gas ratio

Let’s take a look at something that was on everyone’s radar this summer (hark, Lisa Zembrodt on CNBC discussing the topic du jour) until suddenly it disappeared without so much as an au revoir. So without further ado, we revisit the oil/gas ratio: 

crude natty2

Among various other stuff, I have two pieces of paper pinned to my cubicle wall  – one is a picture of Kent Evans, Summit’s Marketing Manager (a picture that never fails to amuse me), and another is Bob Farrell’s 10 Rules For Investing. Bob Farell was a legendary chief strategist at the now-sadly defunct Merrill Lynch. Rule #1 from Mr Farell states: Markets tend to return to the mean over time.

Why so sad?

Why so sad, Mr Evans?

So let’s cut to the chase and slice and dice our burrito. The interesting part about this ratio is that it illustrates the dichotomy of crude oil and natural gas pricing this year – the ratio was relatively unaffected by last year’s great commodity bull run and subsequent crash.

It wasn’t until 2009 that the ratio blew out as crude oil rebounded, and natural gas continued to tank, reaching a crazy-record ratio of 27. However, since the summer we have seen this ratio crumble, along with the interest in it. The ratio has now fallen below the near-term ‘mean’ – the 200-day moving average (blue line on the chart). 

Referring back to Mr Farell’s first rule, three possible short-term scenarios are:

1) natural gas will rise, but crude oil will rise at a faster pace
2) natural gas will trade sideways, but crude oil will rise
3) natural gas will fall, but crude oil will fall at a slower rate

Given that natural gas is at an eleven-month high and crude oil is at a two-month low, the immediate assumption is for a reversal in each of their current trends. However, as we know in commodity markets, nothing can be taken for granted. After all, Exxon Mobil’s acquisition of XTO Energy this week is betting on a further narrowing in the oil/gas ratio. Sometimes all we can do is base our expectations on the smarts of such people as Mr Farell, and avidly watch how the situation unfolds.

1 Comment on this post:

  1. […] above 25. We have taken a look at this ratio a couple of times over the last few years (first here, then here) as it has rocketed higher, but surely it has now reached the stratosphere and is set to […]

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