Raymond James: Gas, Fuel Oil Prices Are Re-linked

As natural gas prices soared last winter, significant switching from natural gas to residual fuel and heating oil made the "linkage" between the commodities all too clear, according to Raymond James & Associates' John Gerdes in an energy brief released last week. Although natural gas is considered the fuel of choice to supply the nation's growing power needs, the last five months of 2000 showed that price can change everything.

Raymond James' said that power generators began to switch from gas to fuel oil as early as August, with major changes occurring during the September-November period. The November-to-December change was the greatest, however, as the gas industry saw a 2.9 Bcfe/d reduction in demand for power generation.

Fuel switching was not the only measure of demand reduction late last year, as the analyst's models showed a "sharp reduction" in industrial consumption mostly from the chemical and metal industries. The combination of factors along with some conservation has allowed the gas market to get back in equilibrium with the equivalent price of oil products.

"In our view, the market's short-term capability to switch a significant percentage (5%) of demand away from natural gas and toward heating oil means the equivalent price of heating oil is likely to become the long-term determinate of natural gas prices," said Gerdes.

However, Raymond James warns that the gas market may be susceptible to significant downward pricing pressure this April and May, as the oversupply of gas meets the slowdown in industrial demand coupled with conservation efforts during the typically low power demand period. Once the summer arrives, so too will the demand for gas-fired generation, which will force gas prices to rebound back to the equivalent price of heating oil, the analyst said.

The ability of power generators to switch their fuel supply, Gerdes said, has become a significant factor in today's market and has re-linked oil and gas prices.

"Assuming no increased environmental limitations on burning residual/heating oil, we expect the equivalent price of residual fuel oil (currently $4/Mcfe --- New York Harbor) to put a floor under gas prices, while the equivalent price of heating oil ($6/Mcfe --- New York Harbor) is a probable ceiling," said Gerdes.

Regarding energy stocks, Raymond James said it would avoid being overly aggressive in the stocks until it is clear that gas prices have bottomed, which will not likely occur until June. After gas prices stabilize, "back up the truck because gas prices are likely to rapidly re-engage equivalent heating oil prices later this summer," the analyst said.

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