Natural Gas Heats Up Inflation

Was it only last week that I was decrying the fraud of core inflation in regard to food prices? So many bad economic policies, so little time. Maybe I should start a daily blog before someone else gets that idea.

We always can count on natural gas to provide a few interesting financial and economic tidbits, such as last week's story in The Wall Street Journal about how higher home heating prices were really starting to bite household budgets. In addition, a story was circulating among energy traders how someone was on the wrong side of the March-April 2009 natural gas spread trade in a manner reminiscent of 2006's Amaranth trading fiasco.

Given the awful winter we have been having in Chicago and the generally high demand for space-heating fuels throughout the eastern half of the country, the time has come to ask whether high and rising natural gas prices will push the whole consumer price index higher relative to core inflation.

The answer is yes. And the bad news is that home heating prices have been rising relative to the CPI ex-energy even during a period when six-month strips of natural gas futures have not risen anywhere near as fast as have petroleum prices. As half the country heats with natural gas, this suggests a great vulnerability to rising natural gas prices in the future and the potential for an even-greater divergence between "headline" and "core" inflation.

Home Heating Costs Have Been Exceeding CPI Ex-Energy

Click here for larger image.

Relative Pricing

Even though crude oil and natural gas prices often are unrelated, a topic I last discussed in January 2006, as long as there are possibilities for substitution, it is important to compare them in local markets. Natural gas often competes with No. 6 residual fuel oil in industrial applications and with No. 2 heating oil in residential and commercial space heating applications. If we compare the three fuels in New York, the epicenter of heating oil usage, we see that natural gas and No. 6 oil are starting to converge, but that No. 2 oil is still vastly more expensive than natural gas.

Comparative Delivered Prices in New York

Click here for larger image.

The conclusion is simple and obvious: Unless petroleum markets collapse, natural gas has room to rise in competition with other fuels.

---

Howard L. Simons is president of Simons Research, a strategist for Bianco Research, a trading consultant and the author of The Dynamic Option Selection System. Under no circumstances does the information in this column represent a recommendation to buy or sell securities. While Simons cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.

TheStreet.com has a revenue-sharing relationship with Trader's Library under which it receives a portion of the revenue from purchases by customers directed there from TheStreet.com.