Why Oil And Gas Are Different

Peak Oil occurred in the US in 1970, but a new record for natural gas production may be set soon. This divergence explains why oil’s value grows while natural gas’ value declines.

Oil prices have bounced back from lows in the 30’s earlier this year to around $80 per barrel today. Natural gas prices, meanwhile, have recovered less from summertime lows, from below $3 per Million BTU to $4 today. Oil and gas prices are historically correlated, as the two fossil fuels are often produced from the same wells and share overlapping uses in industry, residential heating, and other sectors. Why have prices for these commodities decoupled, and will this continue in the future?

Here are two graphs, depicting long term US production of oil and natural gas:

US Oil Production

Since its peak in 1970, US oil production has declined from 9.6 million bpd (barrels per day) to 4.9 million bpd, a decline of 49%.

US Natural Gas Production

Natural gas production set a record of 22.65 TCF (trillion cubic feet) in 1973, but 2009 is on pace to reach within 3% of the old record, and 2008’s production of 21.26 TCF is only 6% less than record.

The long term histories of the two fossil fuels show a fundamentally divergence in path. Domestic oil production peaked decades ago, while natural gas production is poised to set a new record if  the market demands it. While Peak Oil is now in the rear-view mirror in most countries, and could be quite close worldwide, Peak Natural Gas has yet to even occur domestically. In addition, oil status as the world’s primary transport fuel is proving difficult to change [1], while natural gas competes against coal, nuclear, and renewables in the market for electricity production. This situation explains the breakdown of the historic price relationship between oil and natural gas, which is unlikely to return soon.

[1] The EIA projects that 3% of new car sales in 2030 will be PHEVs, or plugin hybrid electric vehicles. Even if PHEV sales accounted for 100% of all new car sales, it would take twenty years to replace all existing cars on the road (since the US has over 200 million vehicles and annual car sales around 10 million). The EIA’s projection makes it clear the PHEVs won’t have a significant impact absent an oil price shock that forces a change in behavior.

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