GO
Loading...

Schork Oil Outlook: $100 Crude Bearish for Natural Gas?

Drilling activity remains high. Crude pricing is strong, and margins are good. Growth in the rig count has slowed due to the continued shift away from dry gas toward more oil-directed drilling, natural gas formations rich in associated oil or natural-gas liquids. The liquid-rich Permian basin and Eagle Ford shale areas in South Texas are booming.

- The Beige Book
The Federal Reserve Board, Jan. 12, 2011

This anecdote from the Fed dovetails with what we have been seeing in the LPG markets (especially propane and ethane) since October. Fractionation spreads or fracs (margin between LPGs and natural gas) have been trading at highs, ?$10 per MMBtu for propane and ?$4.5 per MMBtu for ethane, not seen since the 2008 bubble.

As such, despite a moribund gas market, processors are benefiting from the rally in crude oil.

For example, the ratio between Nymex crude oil for February 2011 delivery is currently trading at 2.1/1, i.e. 1 crude oil contract can purchase 2.1 natural gas contracts. A year ago the February 2010 ratio expired at 1.4/1.

Given that more than 90% of the value of propane and 55% of ethane is derived from crude oil, intuitively, midstream operations benefit from the strength in crude oil and weakness in natural gas by stripping out wet gas (LPGs) and cashing in on the frac spreads.

Therefore, Wall Street’s infatuation with crude oil (see CFTC report for end of 2010) will likely keep a bid in the market, hence the Fed’s observation of the “… shift away from dry gas toward more oil-directed drilling, natural gas formations rich in associated oil or natural-gas liquids.”

Bottom line, despite the Street’s scorn for natural gas (see CFTC report for end of 2010), demand from gas processors for production, be it from associated gas fields or shale plays, will likely remain stout.

For instance, since the start of the 2000s the correlation between the propane frac and the number crude oil and natural gas wells drilled, four months later, is 56% and the correlation to total U.S. rigs (Baker Hughes) with a three month lag is 65%.

This will in turn compound the current glut in supply and discussed in yesterday’s issue of The Schork Report , set the table for another ugly year for gas bulls on Wall Street.

Second Opinion:

NatGas Pains May Soon Be Investor Gains: Kaminsky's Call

_________________________

_________________________

Stephen Schork is the Editor of The Schork Report and has more than 17 years experience in physical commodity and derivatives trading, risk systems modeling and structured commodity finance.

Featured