One common misconception about energy trade is that oil and natural gas markets operate the same way. As extractive industries with similar end uses, oil and gas have many similarities in the upstream and downstream sectors. The main difference between the two lies in the midstream, or transit, sector. Companies can move oil from the wellhead to the pump via train, tanker or pipeline with relative ease. Because of this characteristic, oil is a globally traded commodity with a high level of fungibility, meaning that the global oil market functions much like a bathtub.1 By comparison, natural gas is far more difficult to transport economically over long distances because of its gaseous state. Therefore, it is most commonly transported via pipeline, a far more inflexible type of transportation than ships or trucks.2 The rigidity of gas transport infrastructure often requires that suppliers and end users are tied together through both physical infrastructure and long-term contracts. This is the mechanism through which many observe Europe to be beholden to Russia for its natural gas.
Liquefied natural gas (LNG) is the process through which natural gas is cooled to the point that it becomes liquid and is transported via large, pressurized tankers. This method of transporting natural gas is very capital-intensive and has only been implemented on a limited scale worldwide. As technology improves and costs continue to drop, LNG may play an instrumental role in liberalizing the natural gas market, enabling it to operate more like the current global oil market.
There are several oil indexes used to price crude oil coming from different places around the world. These indexes represent the different characteristics of the various crude blends, since some are less viscous and contain less sulfur than others, making them easier to refine. Despite these different crude indexes, the global oil price largely centers on the Brent index.3 Natural gas, on the other hand, does not have a global price and is instead priced in one of three primary ways, depending on where in the world the transaction is taking place. In North America, natural gas is traded as its own commodity, much like oil.4 As such, the price is determined independently of other commodities. In Asia, natural gas spot prices are pegged to the price of oil. Since gas contains less energy per unit than oil, this pegging mechanism raises the price of natural gas in Asia.5 In Europe, natural gas is traded via long-term supply contracts with pre-negotiated pricing regimes.6 Natural gas pricing is trending toward the North American model, which allows for spot and futures markets and treats natural gas as a commodity separate from oil.
[1] http://www.energyandcapital.com/articles/natural-gas-prices-vs-crude-oil-prices/4671
[2] http://www.energyandcapital.com/articles/natural-gas-prices-vs-crude-oil-prices/4671
[3] http://www.investopedia.com/articles/investing/102314/understanding-benchmark-oils-brent-blend-wti-and-dubai.asp
[4] http://www.oxfordprinceton.com/news/latest-news/338-should-natural-gas-prices-in-europe-and-asia-be-de-linked-from-oil.html
[5] http://www.oxfordprinceton.com/news/latest-news/338-should-natural-gas-prices-in-europe-and-asia-be-de-linked-from-oil.html
[6] http://www.oxfordprinceton.com/news/latest-news/338-should-natural-gas-prices-in-europe-and-asia-be-de-linked-from-oil.html