The Long-Run Oil-Natural Gas Price Relationship and the Shale Gas Revolution

Abstract

The gas extraction technological developments of the 2000s have allowed shale gas production, which in the US has become a significant part of the total gas production. Such a significant change might have affected the long-run relationship between oil and natural gas prices postulated by several authors. By using monthly data of oil and gas prices, as well as gas quantities from 1997 to 2013, we test for the presence of a longrun relationship, allowing also for possible breaks. We first show the stationarity of gas quantity data before the production of shale gas and the existence of a break in the trend (and in the intercept) on the integrated gas price time series, by the time shale gas enters the market. Then, applying a Vector Error Correction Model, we show that shale gas production has affected the relationship across variables. Gas quantities become relevant in the formation of gas prices after the beginning of shale gas production, while impact of oil prices on the gas ones doubles. However, on the basis of the available data, it is not unequivocally possible to assess whether or not a new long-run relationship between oil and gas has been established.

Keywords: Shale Gas, Natural Gas, Crude Oil, Cointegration, Vector Error Correction Models

JEL Classification: C01, C32, Q40, Q41