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December 08, 2005

Crude Oil vs. Nat. Gas -- A Contrarian's Hypothesis
by Rob Kirby

Last week in this space, I wrote about the recent - post Katrina/Rita - pull back in the prices of energy [crude oil and Nat. Gas specifically]. I went on to surmise that, in light of demonstrable and ongoing Gulf Region energy related infrastructure impairment - that pitching one's energy investments on the basis of these recent price declines might be foolhardy - suggesting that folks should perhaps pay close attention to the weather prognosis for the Northern U.S. as it relates to and determines heating demand. To draw a little more attention to last week's summary; I would like everyone to take a look at the following [Nov. 29, 2005] research prepared by the 'widely read' Kurt H. Wulff, CFA of Independent Energy Valuation:

Summary and Recommendation

Attesting to global supply limitations, some energy prices have taken flight in Europe with the advent of colder weather. Current daily price for German electricity and U.K. natural gas about tripled in recent weeks. An acute need for immediate supply of clean energy has consumers in the U.K., Spain, the U.S. and Japan scrambling for the few tanker loads of liquefied natural gas that may be obtained in the spot market. Our natural gas mentor and pioneering consultant on global natural gas and LNG, Mr. Jim Jensen, tells Barrons, "You could get a bidding war for Atlantic LNG cargoes".

Mr. Wulff goes on at length singling out "clean energy" - discussing the merits of individual oil and gas companies, as well as refiners - from small to mid to large cap - with a splendid analysis of numerous individual companies using his own proprietary rating system.

Having read Mr. Wulff's most recent report, I completely and utterly commend him for his efforts. But, being the contrarian that I am - I have a few questions:

1] - What's the real reason that Wulff's research is centered on 'clean power' generally and Nat Gas particularly?

What bothers me about this anecdotal observation by Mr. Wulff is his exclusion of "oil" as the culprit or "root cause" for 'higher prices'.

2] - Now, being the curious contrarian that I am, I want to know why crude oil is not the focus of heightened energy costs.

A Few Facts

Energy, like gold, is viewed by U.S. authorities as being highly strategic and therefore, its price is of paramount importance in maintaining economic stability [everything from the stock market to the value of the U.S. dollar]. World energy prices are arguably "set" or at least highly influenced in the U.S. - on exchanges like NYMEX and COMEX. It also just so happens that the U.S. has at its disposal a [SPR] Strategic Petroleum Reserve - in much the same way the U.S. is alleged to hold vast quantities of gold reserves at places like Fort Knox - whose gold has not been independently or properly audited since the Eisenhower Administration in the 1950's. My question is this:

Who really knows how much oil there is in the SPR [Strategic Petroleum Reserve Inventory]? Is there a giant "dip stick"? After all, energy derivatives contracts are "swapped" and traded much more so than precious metals, aren't they? If nothing else, we at least learned that from ENRON, didn't we?

Now Consider

The U.S. government [or its surrogates] is often accused of utilizing surreptitious activity to influence the gold market - utilizing 'Central Bank physical' and a generous array of derivatives or 'paper gold.' If, for a moment - you accept the notion that there may be a shred of truth to these accusations - would it not be logical to consider that similar activity would be undertaken in a similarly strategic commodity like oil?

There is not an equivalent to oil's SPR in Natural Gas . Perhaps this is why Natural Gas, from a price perspective, is the 'thin edge of the wedge' leading energy prices higher?

In any case, let's benchmark the price of crude oil - as expressed by NYMEX crude oil futures - shall we, as of Friday Dec. 2, 2005 at 59.32 per barrel of 'light sweet crude.' Now, let's take a look at the corresponding price of Natural Gas for the same date - as expressed by the Henry Hub Gas Future [$/MMBtu] - for the same date at 13.93.

My Hypothesis and Conclusion

Over the next few months, let's track the changes in price [on a percentage basis] of crude oil versus Natural Gas, shall we. My hunch is that there will be a rather large divergence in relative prices - because Natural Gas is perhaps the only strategic commodity that is truly "above being rigged" - only because no one has enough of it to do so.

Rob Kirby
Kirby Analytics

Copyright © 2004 - 2006 Rob Kirby

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