Oil Gas Ratio At Extreme Levels

By Eric Fox | June 18, 2009 AAA

The ratio of oil to natural gas prices is at a multi-year high, providing an opportunity for investors with a speculative streak to make a bet on whether natural gas moves up in price or plummets. Many traders watch the relationship between the prices of oil and the price of natural gas, and plot this relationship on a chart. The ratio is currently at 19, which is at a high level relative to its history.

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Trading Options
Investors can make a bet on the price of natural gas moving higher by buying the United States Natural Gas ETF (NYSE:UNG), which tracks the price of natural gas by purchasing the front month NYMEX futures contract.

Another ETF out there is the First Trust ISE-Revere Natural Gas ETF (NYSE:FCG). This ETF doesn't buy natural gas futures; it buys common stocks that get a substantial portion of revenue from the production of natural gas. FCG has already seen a strong move of 80% off of its 52-week low.

There are some things that investors should understand before plowing into this trade. First, the ratio can correct the other way, with oil moving down in price. The United States Oil ETF (NYSE:USO) tracks the price of oil using futures, and investors can short this ETF if they feel that oil will tumble.

Someone buying UNG is not exactly making a contrarian bet, as the dollar volume for UNG relative to USO has soared to 80%, a two year high indicating that the consensus is that UNG will move higher.

Second, UNG must rollover its futures contracts to the next month's contract as they reach expiration. This rollover period runs from June 12-17, and can distort the price of the underlying ETF, usually on the downside. (To learn more, see ETFs Provide Easy Access To Energy Commodities.)

Oily Stocks
The stock market has not distinguished between oil and natural gas producers when bidding up the price of exploration and production stocks. Whiting Petroleum (NYSE:WLL) and Denbury Resources (NYSE:DNR), which are considered "oily" stocks by the street, are up 130% and 200% respectively, off their 52-week lows.

Exploration and production stocks that produce mostly natural gas have shared in this rally as well. Chesapeake Energy (NYSE:CHK) is up 145% off its 52-week low. Goodrich Petroleum (NYSE:GDP), which has assets in East Texas and Louisiana, has doubled off its 52-week low.

The Bottom Line
Although buying the UNG is a trader's bet, it is grounded in the fundamental belief that the reduction in drilling in North America will decrease gas production and cut inventories down to more reasonable levels. If and when this occurs, the price should move up. The oil-natural gas ratio is at a high level and most speculators and traders seem to feel that natural gas prices will move higher, and have herded into the United States Natural Gas ETF. (For more, read our Oil And Gas Industry Primer.)

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