Bearish information continues to roll in

January 12, 2009

BY Casey Whelan

Dec. 31—Commodity—and energy—prices have generally dropped dramatically over the past six months. Inspecting the price patterns more closely, it is clear that oil prices have dropped significantly more than natural gas prices. The chart shows the relationship between oil and natural gas. A high number implies oil is more valuable relative to natural gas and a low number implies the opposite. The dramatic change in the relationship from oil trading at nearly a 16 multiple to natural gas in July to less than seven in January is truly remarkable and deserves some attention.

The market sent a dramatic price signal that natural gas is relatively more valuable than oil in today's marketplace. There are at least two plausible reasons why this appears to be happening: fundamentals and trade speculation. First, natural gas fundamentals are bearish. Supply is up significantly and demand continues to lag as economic growth disappears. However, oil fundamentals are even weaker. Actual demand for oil has dropped worldwide and expected high demand from developing nations has evaporated. Oil tankers are now floating in the ocean looking for a home.



Second, oil was likely exposed to more commodity speculation since it is a worldwide commodity. Due to the limited supply sources and market uses of natural gas, there was less international trading activity. Oil is produced, shipped and consumed worldwide. The oil commodity bubble was able to grow and expand to a much greater extent than natural gas due to worldwide trade participation. As the commodity bubble burst, oil prices dropped to a much greater extent than natural gas as traders were forced to exit positions.

Bottom line: Due to strong supply and weak demand there is limited opportunity for natural gas prices to increase materially from current levels. The caveat is that oil prices remain soft at or below $65 per barrel.

Casey Whelan, vice president of strategic initiatives, can be contacted at cwhelan@usenergyservices.com.

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