Forecasting Natural Gas Prices

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Forecasting natural gas prices using cointegration technique

Dr Salman Saif Ghouri
Abstract This paper uses Augmented Dickey-Fuller and Phillips-Perron technique for determining whether individual crude oil prices (West Texas Intermediate, Brent, Japan crude cocktail) and natural gas prices- Henry Hub (HH), National Balancing Point (NBP), European and Japanese liquefied natural gas (LNG) prices are stationary or non-stationary. It then applies Johansen and Juselius cointegration technique for establishing long-run correlation between respective oil prices and natural gas prices. The paper concludes that all individual series pertaining to oil and natural gas prices are non-stationary and indeed having long-run relationship, despite short term drift. Ordinary least square method was used to forecast individual natural gas prices in various markets, assuming of course, that historical relationship continues to hold with respective oil prices throughout the forecasting period. Natural gas prices in each of the markets are expected to be stronger during 2005–25 as compared to respective historical average prices showing the tightness of the market. The mean NBP and HH forecast during 2005–25 are expected to be 92 and 84 per cent stronger than the historical average, whilst LNG prices in Japan continue to exhibit stronger trends during the forecast period as compared to rest of the markets in Europe and North America – showing greater dependency of imports and security of supply considerations.

December 2006

2006 Organization of the Petroleum Exporting Countries


Dr Ghouri is Senior Economist at the Business Environment Section Corporate Planning of Qatar Petroleum, Doha, Qatar.


2006 Organization of the Petroleum Exporting Countries

OPEC Review


NLIKE oil, natural gas markets are quite different and generally regionalised. The reason being that most of the natural gas resources are located well away from the main consumption centres and it is expensive to transport gas over a long distance vis-à-vis pipeline or liquefied natu-

ral gas (LNG). It is also expensive to consume gas close to the source (domestically) due to high capital investment required for the development of gas infrastructure. For example, at the end of 2004, out of global natural gas consumption of 2,689 billion cubic metres, only 502 bn cu m was traded as pipeline gas and 178 bn cu m as LNG.1 Over the years, Europe has emerged as the major consumer of natural gas-traded as pipeline gas. Altogether, over 67 per cent of global natural gas traded as pipeline ends up in Europe (45 per cent as a result of internal trade, 44 per cent imports from the former Soviet Union and ten per cent from Algeria). The United States of America (US) imported 102 bn cu m from Canada while it exported about 8 and 11 bn cu m to Canada and Mexico (table 1). Apart from Europe and North America the rest of the world only accounted for 43.35 bn cu m (C&S America 15.74 bn cu m, Asia Pacific 15.25 bn cu m, Middle East 11.06 bn cu m and Africa 1.3 bn cu m). In contrast, Asia Pacific dominates LNG trade. In 2004, the region accounted for 67 per cent of global LNG imports and 47 per cent of exports. Middle East is becoming the fastest growing LNG producer and expected to meet the increasing natural gas demand of both the Atlantic and Pacific basin (table 2). As a result of the long distances involved in the transportation of natural gas from major production to consuming countries whether traded as pipeline or LNG, prices often diverge across and within regions. Nevertheless, regional prices usually are closely aligned with each other, because of their direct and indirect linkage with oil prices – reflecting the close competition between gas and petroleum product prices. Until the market becomes (liquid)2 competitive, natural gas prices will continue to be indexed to oil prices directly or indirectly. In a competitive market the reference prices...
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