IN THE NEWS: When -- if ever -- will the oil-gas price gap close?

The dramatic decoupling of crude oil and natural gas prices in 2009 has created a riddle of profound importance to energy investors and company balance sheets, two Massachusetts Institute of Technology researchers conclude in a new study: How long before the diverging prices come back in line?

Companies that rushed to develop "dry" shale gas acreage now are scrambling to sell major parts of their holdings to raise cash and reinvest in oil and gas liquids regions, where the output is currently worth more than 30 times the energy value of "dry" gas, says John Parsons, co-author of the study "The Weak Tie Between Natural Gas and Oil Prices," published in Energy Journal.

It will be a good gamble for companies like Chesapeake Energy Corp. and Encana Corp. that are making the switch if oil and liquids stay markedly richer than dry gas and a punishing one if oil and gas prices converge too soon.

"That's why it's so important to understand whether the decoupling is driven by the short-term changes in the weather, or whether it's driven by longer-term technology shifts," said Parsons, executive director of the MIT Joint Program on Global Change.

"One of the points in our paper is that people operate with rules of thumb and they take them for granted. They get too comfortable with those rules," Parsons said.

As gas prices began to fall away from oil in 2009, many in the industry believed this was temporary and that gap would close again restoring the value of shale gas. It didn't happen.

"In the past four years, you've seen the rug get pulled out from some companies, and they were long in realizing that change," Parson said.

Now opinions are changing. "Companies are looking at decoupling and asking, is this a long-term change, or only for nine months?" he said in an interview. "Companies are now more convinced that technological changes have fundamentally broken the two prices apart."

Changing rules and ratios

Unfortunately for the industry and its investors, the answer is elusive, he said.

"It seems natural to imagine that the price of oil and the price of natural gas would tend to rise or fall in tandem," Parsons and MIT co-author David Ramberg wrote.

"They are both energy carriers, with one barrel of crude oil having approximately the same energy content as six million British thermal units [MMBtu] of natural gas. This rough logic would argue that the price of a barrel of crude oil should equal six times the price of an mmBtu of natural gas. If the price of natural gas rises by $1 [per] mmBtu, then the price of crude oil should rise by $6" per barrel.

The 6-to-1 comparison of the two fuels' energy values is challenged by many in the industry, they wrote. "The two fuels have different costs of production, transportation, processing and storage, and they serve different portfolios of end uses with only a modest overlap. The two fuels also have different environmental costs." Other rules of thumb have emerged, include a simple 10-to-1 ratio to compare oil and gas prices.

Often, the prices have marched together. "The price spike of 2008 is the most dramatically clear example of this, as the two price series seem to move almost in lock step. The more lasting price run-up from 2003 through 2007 also clearly reflects some tie between the two price series," the authors wrote. "Even in the time period before 2002, this rough relationship seems to show up, though with less clarity."

In December 2008, crude oil was $32 a barrel and natural gas was $5.44 per MMBtu -- roughly a ratio of 6-to-1. But by the start of September 2009, oil had risen to $68 per barrel, pushed up by the global demand, while landlocked U.S. natural gas had sunk to $1.88 per MMBtu -- a ratio of more than 36-to-1, they said. "Some believe that the recent price movements reflect a permanent rupture of the old tie between the two price series -- a decoupling -- caused by fundamental changes in the industry," they said.

A new driver?

The split has happened before, they say. In the 1990s and early 2000s, it went in the opposite direction. Technological innovation -- the development of efficient combined cycle gas generators -- and the shift to competitive electricity markets caused a "dash to gas" in the power sector, and this surge in demand sent gas prices much higher than the equivalent price of oil, they note.

This time, it is the new technology of horizontal drilling that has opened up previously uneconomical shale gas regions, Parsons said.

"So, is the price of natural gas tied to the price of oil, or not?" the authors asked.

They conclude that there is a statistically significant relationship between the two energy prices, but the pattern is often broken. Gas prices are much more volatile that oil.

But there is not yet evidence that the relationship between the two prices has been completely severed, either, the authors wrote. "Indeed, it is hard to imagine that natural gas and oil prices could decouple completely and permanently."

If this year's drop in gas prices was significantly due to an unusually mild winter in the United States, then a return to normal winter could narrow the gap quickly and dramatically.

The fracking phenomenon could produce much longer-term disparities, however, and that may not be clear until the industry learns how much oil and gas will really be extracted from the shale formations thousands of feet below ground and whether fracking works better in gas plays than in oil and liquid acreage, he said. The industry is still too new to reveal those answers.