Prices for CME/NYMEX West Texas Intermediate (WTI) have been on a rollercoaster this week – falling under $30/Bbl one minute then jumping back over $32/Bbl the next. Yesterday (February 4, 2016) WTI closed down 56 Cents at $31.72/Bbl. CME Henry Hub natural gas futures fell back under $2/MMBtu to close at $1.972 yesterday. That left the crude-to-gas ratio (WTI divided by Henry Hub) at just over 16 X – a little higher than the 15 X range we’ve been seeing this year. That is nearly half as much again as the 27X average between 2009 and 2014. The futures market implies that low ratios could continue for years – with December 2024 values implying a ratio of 13.3 X. The potential consequences of these low ratios are dramatic for the natural gas liquids (NGL) business as well as the competitiveness of U.S. natural gas in international markets. Today we describe the implications.
In the First Episode in this two part series we reviewed the history of the crude-to-gas ratio that before 2008 averaged 7.5X but jumped to an all time high of 54X in 2012 during the “Great Divide” when oil prices were over $100/Bbl and natural gas sank below $2/MMBtu. A high crude-to-gas ratio between 2009 and 2014 (averaging 27X) underpinned a Golden Age of natural gas processing as well as a boom in crude production from shale. Producers diverted their drilling budgets to gas liquids and crude plays to exploit higher prices. In the meantime natural gas production continued to grow despite lower prices – in part because of associated gas that came along with high liquids production. In the past 19 months (since June 2014) crude prices have fallen hard and faster than natural gas – leading to the ratio languishing in the mid teens by December 2014. Despite some recovery above 20X for brief periods in 2015 the crude-to-gas ratio started 2016 by tumbling to its lowest point since March 2009 (12.5X) on January 20, 2016. With crude and natural gas markets oversupplied and inventories for both commodities brimming over – the crude-to-gas ratio looks set to stay low for a while. In this second episode we look at the consequences of a continued low crude-to-gas ratio.
We start by looking at the forward curve of the ratio to see today’s futures market expectations. The chart in Figure #1 shows the forward curve of the ratio as of February 4, 2016 – providing an indication of current market sentiment about the next few years based on CME/NYMEX futures contracts for WTI divided by Henry Hub natural gas (see Living in Fast Forward for more on forward curves). The blue line is the monthly value of the ratio going out to December 2024 (that is as far out as crude trades – natural gas goes out further). The red line is the annual average of each calendar year. That annual average is 16.4X in 2016 and stays between 15 X and 16 X through 2023 when it falls to 14.5X in 2024. The monthly ratio curve has a seasonal pattern – lower in winter and higher in summer – because that is the shape of the natural gas forward curve. That means ratios in the winter drop well below the average – falling to 12.3 X in December 2024 at the end of the curve. As we have noted recently prices further on the crude forward curve are increasing from today’s low levels (see The Downward Spiral) but the recovery is slow and crude is still only $52/Bbl in 2024. The natural gas curve does not show much sign of recovering from today’s values under $3/MMBtu until 2018 and reaching a peak of $3.78/MMBtu in December 2024. The ratio curve dips lower after 2019 because gas prices are rising faster than crude recovers. The implication from the forward market is therefore that the crude-to-gas ratio will continue to languish at or lower than current levels.