Oil and natural gas prices in the US have historically tracked each other on the basis of relative energy values (oil has around 6 times the energy value of gas). Up until around 2008 any difference in relative values has been rapidly arbitraged away over a period of a few years or so. However, since 2008 the difference in relative values blew out to enormous proportions. While the collapse in oil prices since mid-2014 has brought energy markets more into line there is more to do which could have implications for both crude (WTI) and natural gas prices.
Between 1990 and 2008 the average energy value of natural gas versus crude was 72% (the grey line in the chart). Now although there was volatility around this level the market arbitraged away the difference in price over a period of a few years or so. Since 2008 things changed. The ratio of gas to WTI over the past six years has averaged 29%.
While the fracking boom in the US impacted both gas and oil production the impact on the oil market was hidden by large unplanned problems in other key producers (think Iraq, Libya, Iran etc). Large manufacturing companies in the US (e.g. chemical producers and the like) saw low gas prices and thinking that high oil prices were here to stay invested accordingly, in the case of chemical companies placing large investments in ethylene capacity. To an extent this is what the market should be doing, arbitraging away the differences in price (as a side note the question for some is whether they have now over invested?).
So does the sharp drop in the oil price mean that the market has finished its work? Well even at current oil prices the ratio between gas and WTI is still only 33%. Remember the average pre-2008 was 72%. To get back to this ratio clearly WTI has to fall, natural gas prices have to rise or a combination of the two. At current market prices if oil shouldered all the responsibility WTI prices would need to fall to $22 per barrel!
Related article: Oil prices: History does not repeat itself, but it often rhymes