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Modeling UK Natural Gas Prices when Gas Prices Periodically Decouple from the Oil Price

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  • Frank Asche
  • Atle Oglend
  • Petter Osmundsen

Abstract

When natural gas prices are subject to periodic decoupling from oil prices, for instance due to peak-load pricing, conventional linear models of price dynamics such as the Vector Error Correction Model (VECM) can lead to erroneous inferences about cointegration relationships, price adjustments and relative values. We propose the use of regime-switching models to address these issues. Our regime switching model uses price data to infer whether pricing is oil-driven (integrated) or gas-specific (decoupled). We find that UK natural gas (ICE) and oil (Brent) are cointegrated for the majority of the sample considered (1997-2014). Gas prices tend to decouple during fall and early winter, when they increase relative to oil consistent with heating demand for natural gas creating gas-specific pricing. Using the model to infer relative values when evidence favors integrated markets, we find that the industry 10-1 rule-of-thumb holds, meaning that the value of one barrel of oil is 10 times the value of one MMbtu of natural gas.

Suggested Citation

  • Frank Asche & Atle Oglend & Petter Osmundsen, 2015. "Modeling UK Natural Gas Prices when Gas Prices Periodically Decouple from the Oil Price," CESifo Working Paper Series 5232, CESifo.
  • Handle: RePEc:ces:ceswps:_5232
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    Cited by:

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    3. Chiappini, Raphaël & Jégourel, Yves & Raymond, Paul, 2019. "Towards a worldwide integrated market? New evidence on the dynamics of U.S., European and Asian natural gas prices," Energy Economics, Elsevier, vol. 81(C), pages 545-565.
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    6. Halser, Christoph & Paraschiv, Florentina & Russo, Marianna, 2023. "Oil–gas price relationships on three continents: Disruptions and equilibria," Journal of Commodity Markets, Elsevier, vol. 31(C).
    7. Pablo Cansado-Bravo & Carlos Rodríguez-Monroy, 2018. "Persistence of Oil Prices in Gas Import Prices and the Resilience of the Oil-Indexation Mechanism. The Case of Spanish Gas Import Prices," Energies, MDPI, vol. 11(12), pages 1-17, December.
    8. Robert Ialenti, 2021. "Rising US LNG Exports and Global Natural Gas Price Convergence," Discussion Papers 2021-14, Bank of Canada.
    9. Miao, Xiaoyu & Wang, Qunwei & Dai, Xingyu, 2022. "Is oil-gas price decoupling happening in China? A multi-scale quantile-on-quantile approach," International Review of Economics & Finance, Elsevier, vol. 77(C), pages 450-470.
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    More about this item

    Keywords

    oil; natural gas; peak load pricing; regime switching; relative value;
    All these keywords.

    JEL classification:

    • F13 - International Economics - - Trade - - - Trade Policy; International Trade Organizations
    • Q27 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Renewable Resources and Conservation - - - Issues in International Trade
    • Q48 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - Government Policy
    • Q35 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Nonrenewable Resources and Conservation - - - Hydrocarbon Resources
    • Q41 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - Demand and Supply; Prices

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