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April 20, 2011

Price ratio of crude oil to natural gas increasing

Source: U.S. Energy Information Administration based on data from Thomson Reuters
Note: The crude oil-to-natural gas price ratio is calculated by dividing the spot price of Brent crude oil ($/barrel) by the spot price of natural gas at the Henry Hub ($/MMBtu.) In the past, the crude oil price most utilized for this calculation was West Texas Intermediate (WTI). Due to the significant current discount of WTI relative to Brent and other crude benchmarks, we use the Brent price here.

The ratio between the spot prices of crude oil and natural gas is a measure of the market's relative valuation of these two fuels. This ratio climbed rapidly in 2009 peaking near 36 on September 4, 2009 and remains very high in comparison to to typical valuations over the past years. In the five years prior to 2009, the ratio averaged about 9. The 2009 increase was driven by both an increase in oil prices, and low natural gas prices held down by increasing shale gas supplies and a mild hurricane season. The ratio has remained high, averaging close to 30 since the beginning of March 2011.

The crude oil-to-natural gas spot price ratio also has implications for both production and consumption. On the production side, a higher ratio encourages operators to drill for oil in preference to natural gas and makes natural gas liquids developments more commercially attractive. This ratio can also influence operator's decisions about where to drill within a supply basin. High crude to gas ratios have encouraged operators to deploy rigs in "oily" (liquids-rich) parts of supply basins containing both oil and gas.

On the consumption side, the crude-oil-to-natural gas ratio also affects end-user decisions–encouraging end users to choose natural gas over products derived from crude oil, such as distillate and residual fuel oil. High relative oil prices limit the role that oil now plays as a substitute fuel for power generation. Increasingly, electric power plants rely upon oil only when natural gas is unavailable or when spot natural gas prices rise to very high levels usually due to winter natural gas pipeline constraints, especially in the Northeast.