Oil and gas markets in the UK: Evidence from a cointegrating approach

The paper examines the relationship between UK wholesale gas prices and the Brent oil price over the period 1996-2003 in order to investigate whether oil and gas prices 'decoupled' during this period as orthodox gas market liberalisation theory suggests. Tests for unit roots and cointegration are carried out and it is discovered that a long-run equilibrium relationship between UK gas and oil prices exists. Moreover, this relationship pre-dates the opening of the UK-Mainland Europe Interconnector. Following a recursive methodology [Hansen, H. and Johansen, S. (1999), Some tests for parameter constancy in cointegrated VAR-models, Econometrics Journal, 2, 306-333.], it was found that the cointegrating relationship is present throughout the sample period. However, the long-run solutions seem to be more volatile. Evidence is provided that the short-run relationship is linear and impulse response functions are used to examine the effects that a shock in oil would have on gas. These findings do not support the assumption that gas prices and oil prices 'decouple'.