Have European natural gas prices decoupled from crude oil prices? Evidence from TVP-VAR analysis

Abstract

Unprecedented increases in European natural gas prices observed in late 2021 and early 2022 raise a question about the sources of these events. In this article we investigate this topic using a time-varying parameters structural vector autoregressive model for crude oil, US and European natural gas prices. This flexible framework allows us to measure how disturbances specific to the analyzed markets propagate within the system and how this propagation mechanism evolves in time. Our findings are fourfold. First, we show that oil prices are hardly affected by shocks specific to natural gas markets, whether in the US or Europe. Second, we demonstrate that oil shocks have limited impact on US gas prices, which points to the decoupling of both markets. Third, we evidence that over longer horizons natural gas prices in Europe are still mostly determined by oil shocks, with idiosyncratic shocks leading to short-lived decoupling of both commodity prices. Fourth, we illustrate that along the gradual shift from oil price indexation to gas-on-gas competition, the contribution of idiosyncratic shocks to European natural gas prices has increased. Nonetheless, we discuss why the notion that EU natural gas and crude oil prices have decoupled might be premature.