Capturing Long-Term Coupling and Short-Term Decoupling Crude Oil and Natural Gas Prices

Abstract

Recent research has focused on the prevailing relationship between crude oil and natural gas prices. Nowadays, it is well acknowledged that crude oil prices often drive natural gas prices. However, their relationship is unstable over time so that it exhibits regime changes. As a result, crude oil and natural gas prices tend to decouple in the short term while coupling together in the long term. Our present work captures the long-term coupling and short-term decoupling behaviors of crude oil and natural gas prices. Using Kalman filter methodology in linear regressions, we describe such time-varying relationship while allowing for stochastic coefficients (e.g. capturing local linear trend, non-stationarity). As a result, our findings open the door to possible short- and/or long-term arbitrage strategies between crude oil and natural gas prices.