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A Formula for Natural-Gas Prices — and Confusion

August 22, 2005

Aug. 21–Energy analysts have long known that the price of natural gas follows that of crude oil. One rule of thumb was the 10-to-1 ratio, that the price of a barrel of crude was 10 times the price of gas. But is that relationship falling apart?

Stephen P.A. Brown, an energy economist at the Federal Reserve Bank of Dallas, heard speculation that the relationship was changing or disappearing, so he went to find out for himself.

In a paper for the Dallas Fed (at www.dallasfed.org), Brown found that the relationship is as strong as ever — as long as you know what the right factors are.

One of those factors is seasonal variations; another is storage variations.

So the real formula is: price of natural gas = (crude oil price x .1503) – .3345 + WSF – (.0265 x ST). WSF is weekly seasonal factor, from a table Brown developed. ST is the percentage deviation from five-year storage levels, a figure released weekly by the Energy Department.

How well does it work? Crude closed at $63.27 on Thursday, the weekly seasonal factor was -0.3579, and the storage deviation was 5.9 percent. Put them all together, and the formula estimates $8.66, just 3.1 percent off the actual figure of $8.93.

Brown says the formula doesn’t account for weather or pipe-capacity problems, but several years of data make clear that oil prices are still the biggest factor in determining the price of gas.

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