A Historical Look at the Natural Gas/Crude Oil Spread

Real-time Monetary Inflation (last 12 months): 2.9%

Recently, in response to our article on the gold/oil ratio ("What's The Gold/Oil Ratio Telling Us?"), a reader puzzled over the relationship of gold to oil and natural gas. "With natural gas so cheap in comparison to oil currently," he noted, "one can see why Exxon is seeing an investment opportunity in that area."

Well, there's more than one way to gauge the cheapness of gas to oil. Seasoned petroleum traders consider the energy equivalence of the two products, measured in millions of British thermal units (mmBTU), when considering their moves. We spelled out how the equivalence is calculated in the feature article "Spreading Oil And Natural Gas."

Traders bank on seasonal variance in the relative value of natural gas to crude with spread trades. One of the most reliable seasonal tendencies in the petroleum complex is the contraction in the discount between September and December. By purchasing natural gas futures in September against the short sale of crude oil, a trader's able to capitalize upon the tendency of gas to appreciate in anticipation of the heating season.

On Monday, the win/loss ratio for the spread ticked up when books were closed for the 2009 season.

This year, the spread would have made $5.48/mmBTU for large traders (those that can trade the spread at its true energy-equivalence) and $3.38/mmBTU for retail traders selling crude vs. gas on a one-for-one contract basis.

Over the past 16 years, the spread's made money 81 percent of the time for the big guys, 69 percent of the time for the hoi polloi.

 

Natural Gas/Crude Oil Spread

 

Last year's result was outsized because of the precipitous plunge in crude oil prices during the Great Deleveraging. Retail traders actually had the edge over professionals because a one-to-one spread overweights crude oil.

A one-to-one spread earned-albeit with considerable interim volatility-a return on margin of 113 percent this year, just in time to finance holiday shopping.