The Relationship Between Crude Oil and Natural Gas Prices

This paper examines the time series econometric relationship between the Henry Hub natural gas price and the West Texas Intermediate (WTI) crude oil price. Typically, this relationship has been approached using simple correlations and deterministic trends. When data have unit roots as in this case, such analysis is faulty and subject to spurious results. We find a cointegrating relationship relating Henry Hub prices to the WTI and trend capturing the relative demand and supply effects over the 1989-through-2005 period. The dynamics of the relationship suggest a 1-month temporary shock to the WTI of 20 percent has a 5-percent contemporaneous impact on natural gas prices, but is dissipated to 2 percent in 2 months. A permanent shock of 20 percent in the WTI leads to a 16 percent increase in the Henry Hub price 1 year out all else equal. Acknowledgements: The authors have benefited from comments and suggestions by William Trapmann, Nancy Kirkendall, Glenn Sweetnam, John Conti, Andy Kydes, and attendees of the Meeting of the American Statistical Association Committee on Energy Statistics with the EIA on April 7, 2006, particularly William Helkie, Cutler Cleveland, and Howard Gruenspecht.