Tuesday, August 11, 2015

Natural Gas versus Crude Oil

Today in the crude oil markets, oil takes a tumble that reverses the gains of yesterday after the Chinese release the news of their devaluation of the yuan. As a result of the weakening of the Chinese currency. speculation of oil demand has decreased. Because oil is priced in the dollar, barrels of oil in the future will be more expensive due to the new exchange rate. Brent and WTI both reacted negatively to the change in fundamentals. This news is coupled with constant reports of weak Chinese stock performance that spur speculators to react bearishly. But such news is predictable especially after a false gain yesterday confused commodity experts fixated on fundamental factors.

Today, I wanted to do some analysis of the natural gas contract price which is traded alongside WTI light crude oil on the New York Mercantile Exchange. More specifically, I was interested in comparing price movements between the two commodities in the past 6 months. Both commodities are inputs in the energy sector with roles in powering our cars (crude oil) and powering our homes (natural gas). As reserves are discovered and expand, natural gas will take over coal as the energy source of the majority of electricity generation. Technologically and environmentally, energy companies are finding that the fossil fuel is more efficient and cleaner than its mined counterpart. As another plus, major oil companies have already developed major gas reserves as the capital intensive process is being covered by corporations already established in the energy sector. Natural gas is by no means new to the industry, but it was never seriously considered energy source until the late 2000's where its use for electricity generation increased substantially. Nevertheless, it is an interesting commodity to monitor alongside crude oil as companies are usually associated with the extraction and processing of both as energy sources. As a result, natural gas has experienced a lot of downward pressure from the oil slump. While supply issues may not be as serious in the natural gas industry, they certainly pose a problem to the dynamics of natural gas pricing.



What is first noticed about the price patterns for natural gas and WTI over the past six months is the difference in shape. Crude oil contracts exhibit a movement characteristic of a parabola that featured a price stabilization earlier in the year followed by a subsequent drop at the beginning of July. Natural gas prices have shown a bouncing motion progressing through lower highs and higher lows. Another initial comment to make is on volume. Natural gas's overall volume is significantly lower than crude oil's as speculation surrounding it does not seem as concentrated as that on crude oil's price. As a result, day to day price changes appear robust which makes identifying a trend that much harder. Look at both charts' recoveries in March and April. Both upward trends last about a month and a half, but WTI's price change was almost 15 percentage points higher than that of natural gas. Also, before the breakout in late April, natural gas price showed a double bottom formation testing its lowest support level twice. It seems quite clear that natural gas intraday volatility trumps that of the speculation driven WTI price, but its overall beta number would be lower than its counterpart (WTI shows a higher high and a lower bottom). An explanation might lie in the technical indicators which tell a mild story with no convincing evidence for trends. The RSI for natural gas contracts never reached a signal value in either direction with few deviations above 60 and below 40. The MACD correctly reacted to the up and down trends as shown by the blue arrows, but any momentum has been dampened for the past two months. It is fair to say that natural gas is reacting to its technicals fairly well but remains dormant with evidence od daily whipsaw due to very neutral technicals, so maybe a breakout or a trend lies in its reaction to crude oil. Take a look at the bottom on WTI's chart occurring on March 17th. Tracing that date over to the price of natural gas shows a similar trend which finished its bottoming  on April 13th, almost a month later. Crude oil short-term simple moving averages passed its long term SMA at the end of April confirming the positive trend. Two weeks later, the same 25-day moving average overtook the 50-day moving average for natural gas, again reflecting the movements seen in the WTI price. Natural gas has shown a tendency to follow a trend similar to its counterpart with a slight delay which could present itself as an opportunity. But after the initial drop and rebound similarities earlier this year, the pattern dissolved beginning in June. Instead of remaining attached, the crude oil market has been shocked by intense speculation while natural gas contracts remain frozen in volatility slowing squeezing prices in a lateral movement that makes position entering difficult. I think there maybe one key observation that could change that opinion. At the end of July, both commodities lost ground after earnings reports revealed massive revenue losses for energy companies, serving as a reminder that these commodities are inevitably connected not just by their roles but by the same corporation. And because crude oil's price dive has been progressing for more than a month now, I suspect natural gas will make a bear run as well. Although, the trend will not be as strong as what we have seen from the WTI spot price, a jagged slope downward  with lower lows and a gradual sell-off due to negative overall sentiment in the energy sector is what I would predict for the near future for the natural gas spot price.

2 comments:

  1. Hi Jacob,

    Given that oil is primarily used for transportation, and natural gas is primarily use for heating and electricity generation I don't believe that the two correlate very strongly.

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  2. Thank you for your comment! I would agree that demand for both products is separated into the categories you have pointed out, but I do believe there is some correlation between them. A lot of oil companies have extensions into the natural gas sphere. For that reason, investor speculation could spill over into the sentiment regarding natural gas prices. If Exxon-Mobil (an integrated oil and gas service) is showing large revenue losses, faith in all operations could be in jeopardy.

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