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

22 Pages Posted: 12 Mar 2015

See all articles by Frank Asche

Frank Asche

Stavanger University College

Atle Oglend

University of Stavanger

Petter Osmundsen

University of Stavanger; CESifo (Center for Economic Studies and Ifo Institute)

Multiple version iconThere are 2 versions of this paper

Date Written: February 28, 2015

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.

Keywords: oil, natural gas, peak load pricing, regime switching, relative value

JEL Classification: F130, Q270, Q480, Q350, Q410

Suggested Citation

Asche, Frank and Oglend, Atle and Osmundsen, Petter, Modeling UK Natural Gas Prices When Gas Prices Periodically Decouple from the Oil Price (February 28, 2015). CESifo Working Paper Series No. 5232. Available at SSRN: https://ssrn.com/abstract=2576649

Frank Asche

Stavanger University College ( email )

PO Box 2557
Ullandhaug
4004 Stavanger
Norway

Atle Oglend (Contact Author)

University of Stavanger ( email )

PB 8002
Stavanger, 4036
Norway

Petter Osmundsen

University of Stavanger ( email )

4036 Stavanger
Norway

CESifo (Center for Economic Studies and Ifo Institute) ( email )

Poschinger Str. 5
Munich, DE-81679
Germany

Register to save articles to
your library

Register

Paper statistics

Downloads
95
Abstract Views
443
rank
173,071
PlumX Metrics