Natural gas trading hub locations
Prior to the deregulation of the natural gas commodity market and the introduction of open access for everyone to natural gas pipelines, there was no role for natural gas marketers. Producers sold to pipelines, who sold to local distribution companies and other large volume natural gas users.
Local distribution companies sold the natural gas purchased from the pipelines to retail end users, including commercial and residential customers. Price regulation at all levels of this supply chain left no place for others to buy and sell natural gas. However, with the newly accessible competitive markets natural gas trading hub locations gradually over the past fifteen years, natural gas marketing has become an integral component of the natural gas industry.
In fact, the first marketers were a direct result of interstate pipelines attempting to recoup losses associated with long term contracts entered into as a result of the oversupply problems of the early s.
Natural gas marketing may be defined as the selling of natural gas. In even looser terms, marketing can be referred to as the process of coordinating, at various levels, the business of bringing natural gas from the wellhead to end-users. The role of natural gas marketers is quite complex, and does not fit exactly into any one spot in the natural gas supply chain.
Marketers may be affiliates natural gas trading hub locations producers, pipelines, and local utilities, or may be separate business entities unaffiliated with any other players in the natural gas industry.
Marketers, in whatever form, find buyers for natural gas, ensure secure supplies of natural gas in the market, and provide a pathway for natural gas to reach the end-user. It is natural gas marketers that ensure a liquid, transparent market exists for natural gas.
Marketing natural gas can include all of the intermediate steps that a particular purchase requires; including arranging transportation, storage, accounting, and basically any other step required to facilitate the sale of natural gas. Essentially, marketers are primarily concerned with selling natural gas, either to resellers other marketers and distribution companies natural gas trading hub locations, or end users.
On average, most natural gas can have three to four separate owners before it actually reaches the end-user. In addition to the buying and selling of natural gas, marketers use their expertise in financial instruments natural gas trading hub locations markets to both reduce their exposure to risks natural gas trading hub locations to commodities, and earn money through speculating as to future market movements. In order to more fully understand the role and function of natural gas marketers, it is helpful to have an understanding of the basics of natural gas markets.
Natural gas is sold as a commodity, much like pork bellies, corn, copper, and oil. The basic characteristic of a commodity is that it is essentially the same product no matter where it is located.
Natural gas, after processing, fits this description. Commodity markets are inherently volatile, meaning the natural gas trading hub locations of commodities can change often, and at times drastically. Natural gas is no exception; in fact, it is one of the most volatile commodities currently on the market. The graph below shows the. The price of natural gas is set by market natural gas trading hub locations the buying and selling of the commodity by market players, based on supply and demand, determines the average price of natural gas.
There are two distinct markets for natural gas: To get the price of natural gas on a specific day, it is the spot market price that is most informative. The futures market consists of buying and selling natural gas under contract at least one month, and up to 36 months, in advance. For example, under a simplified futures contract, one could enter into an agreement today, for delivery of the physical gas in two months. Futures contracts are but one of an increasing number of derivatives contracts used in commodities markets, and can be quite complex and difficult to understand.
Natural natural gas trading hub locations is priced and traded at different locations throughout the country. There are over 30 major market hubs in the U. The futures contracts that are traded on the NYMEX are Henry Hub contracts, meaning they reflect the price of natural gas for physical delivery at this hub. The price at which natural gas trades differs across the major hubs, depending on the supply and demand for natural gas at that particular point.
The difference between the Henry Hub price and another hub is called the location differential. Citygates are the locations at which distribution companies receive gas from a pipeline. Citygates natural gas trading hub locations major metropolitan centers can offer another point at which natural gas is priced. There are two primary types of natural gas marketing and trading: Physical natural gas marketing is the more basic type, which involves buying and selling the physical commodity.
Financial trading, on the other hand, involves derivatives and sophisticated financial instruments in which the buyer and seller never take physical delivery of the natural gas. Like all commodity markets, the inherent volatility of the price of natural gas requires the use of financial derivatives to hedge against the risk of price movement. Buyers and sellers of natural gas hedge using derivatives to reduce price risk. Speculators, on the other hand, assume greater risk in order to profit off of changes in the price of natural gas.
Most marketing companies have elaborate trading floors, including televisions and pricing boards providing the traders with as much market information as possible. Physical trading contracts are negotiated between buyers and sellers. There exist numerous types of physical trading contracts, but most share some standard specifications including specifying the buyer and seller, natural gas trading hub locations price, the amount of natural gas to be sold usually expressed in a volume per daythe receipt and delivery point, the tenure of the contract usually expressed in number of days, beginning on a specified dayand other terms and conditions.
Natural gas trading hub locations special terms and conditions usually outline such things as the payment dates, quality specifications for the natural gas to be sold, and any other specifications agreed to by both parties. Physical contracts are usually negotiated between buyers and sellers over the phone.
However, electronic bulletin boards and e-commerce trading sites are allowing more physical transactions to take place over the internet.
There are three main types of physical trading contracts: Under this type of contract, both the buyer and seller agree that neither party is obligated to deliver or receive the exact volume specified. These contracts are the most flexible, and are usually put in place when either the supply of gas from the seller, or the demand for gas from the buyer, are unreliable.
Baseload contracts are similar to swing contracts. Neither the buyer nor seller is obligated to deliver or receive the exact volume specified. In addition, both parties generally agree not to end the agreement due to market price movements.
Both natural gas trading hub locations these understandings are not legal obligations — there is no legal recourse for either party if they believe the other party did not make its best effort to fulfill the agreement — they rely instead on the relationship both personal and professional between the buyer and seller. Firm contracts are different from swing and baseload contracts in that there is legal recourse available to either party, should the other party fail to meet its obligations under the agreement.
This means that both parties are legally obligated to either receive or deliver the amount of gas specified in the contract. These contracts are used primarily when both the supply and demand for the specified amount of natural gas are unlikely to change or drop off.
The daily spot market for natural gas is active, and trading can occur 24 hours a day, seven days a week. However, in the natural gas market, the largest volume of trading occurs in the last week of every month. The core natural gas supply or demand is not expected to change; producers know they will have that much natural gas over the next month, and consumers know that they will require that much natural gas over the next month.
The average prices set during bid week are commonly the prices used in physical contracts. In addition to trading physical natural gas, there is a significant market for natural gas derivatives and financial instruments in the United States.
In fact, it has been estimated that the value of trading that occurs on the financial market is 10 to 12 times greater than the value of physical natural gas trading. Derivatives can range from being quite simple, to being exceedingly complex. Traditionally, most derivatives are traded on the over-the-counter OTC market, which is essentially a group of market natural gas trading hub locations interested in exchanging certain derivatives among themselves, as opposed to through a market like the NYMEX.
Basic types of derivatives include futures, options, and financial swaps. There are two possible objectives to trading in financial natural gas natural gas trading hub locations Trading in the physical market involves a certain degree of risk.
Price volatility in the natural gas markets can result in financial exposure for marketers and other natural gas trading hub locations players as the price changes over time. A hedging strategy is created to reduce the risk of losing money. Similarly, a marketer who plans on selling natural gas in the spot market for the next month may be worried about falling prices, and can use a variety of financial instruments to hedge against the possibility of natural gas being worth less in the future. Countless strategies exist to hedge against price risk in the natural gas market, including natural gas futures, derivatives based on weather conditions to mitigate the risk of weather affecting the supply of natural gas and thus its market priceetc.
Financial natural gas markets may also be used by natural gas trading hub locations participants who wish to speculate about price movements or related events that may come about in the future. The main difference between speculation and hedging is that the objective of hedging is to reduce risk, whereas the objective of speculation is to take on risk in the hope of earning a financial return.
Speculators hope to forecast future events or price movements correctly, and profit through these forecasts using financial derivatives.
Trading in the financial markets for speculative purpose is essentially making an investment in financial markets tied to natural gas, and financial speculators need not have any vested interest in the buying or selling of natural gas itself, only in the inherent underlying value that is represented in financial derivatives. While great profits may be made if the expectations of a speculator prove correct, great losses may also be incurred if these expectations are wrong.
While the instruments used for hedging and speculation are the same, the way in which they are used determines whether or not they in fact reduce, or increase, the risk of losing money. Now that some of the basics of the natural gas market have been covered, we can examine the function of natural gas marketers. Any party who engages in the sale of natural gas can be termed a marketer, however they are usually specialized business entities dedicated solely to transacting in the physical and financial energy markets.
It is commonplace for natural gas marketers to be active in a number of energy markets, taking advantage of their knowledge of these markets to diversify their business.
Many natural gas marketers are also involved in the marketing of electricity, and in certain instances crude oil. Marketers can be producers of natural gas, pipeline marketing affiliates, distribution utility marketing affiliates, independent marketers, and large volume users of natural gas. A recent study of the origins of natural gas marketers found that 27 percent of the top 30 natural gas marketers in were entities spun off from interstate pipeline companies.
An equal percentage was made up of entities affiliated with local distribution companies. About 30 percent of the top natural gas marketers were originally affiliated with producers, and entities formed from large volume natural gas consumers comprise 6 percent. Finally, independent, newly formed entities represent 10 percent of top natural gas marketers.
Marketing companies, whether affiliated natural gas trading hub locations another member of the natural gas industry or not, can vary in size and the scope of their operations. Some marketing companies may offer a full range of services, marketing numerous forms of energy and financial products, while others may be more limited in their scope. For instance, most marketing firms affiliated with producers do not sell natural gas from third parties; they are more concerned with selling their own production, and hedging to protect their profit margin from these sales.
There are basically five different classifications of marketing companies: They operate on a nationwide basis, and have large amounts of capital to support their trading and marketing operations.
Producer marketers are those entities generally concerned with selling their own natural gas trading hub locations gas production, or the production of their affiliated natural gas production company. Smaller marketers target particular geographic areas, and specific natural gas markets. Many marketing entities affiliated with LDCs are of this type, focusing on marketing gas for the geographic area in which their affiliated distributor operates.
Aggregators generally gather small volumes from various sources, combine them, natural gas trading hub locations sell the larger volumes for more favorable prices and terms than would be possible selling the smaller volumes separately. Brokers are a unique class of marketers in that they never actually take ownership of any natural gas themselves.
They simply act as facilitators, bringing buyers and sellers of natural gas together.
Over the past few months, the power trading market has received quite an education in the commodity trading business. Collectively, the industry is now considerably more astute about credit, price volatility, risk management and the critical importance of a crystal clear definition of the obligations of buyer and seller. Through this process, power trading has started to mature as an industry, and like all mature energy commodities, the market is increasingly concentrating liquidity at a select group of specific geographic locations or hubs.
This geographic concentration of liquidity natural gas trading hub locations to support several positive market developments, including enhanced price discovery, more narrow bid-ask spreads and in general, a more efficient marketplace. But while the hub development process in the power market is natural gas trading hub locations, it is far from complete. And as market participants in other energy commodities have learned, the decision to trade at a natural gas trading hub locations hub using a particular contractual instrument, can natural gas trading hub locations as important - if not more important - than the price of the trade itself.
In fact, the power business already has some battle scars from the shifting of trading hubs and trading instruments. The western hub has a significant level of activity, but limited reliable access to high demand areas, while the east delivery point has the high-demand access, but is occasionally constrained during on-peak hours. Liquidity dried up in both halves of PJM and took several weeks to recover.
A number of traders that were caught with out-month positions at the old KV hub delivery point incurred substantial financial losses to unwind their positions. Similar to PJM, liquidity dried up and several traders with out-month deals had to do a lot of work to protect their positions. Clearly "Hub Trading Delivery Risk" is a component of the trade that deserves a lot of attention.
What lessons can be elicited from the commoditization of crude oil, petroleum products, natural gas? Why some hubs could succeed while others fail? A good definition and description of a power hub can be found on the PJM webpage, as described below:. A hub natural gas trading hub locations an aggregation of representative buses grouped by region.
Hubs create a common point for commercial energy trading. What is the business reason for Hubs? Hubs create a common point for commercial trading contracts to settle with or without going to physical delivery.
Hubs are intended to create price signals for geographical regions of the control area by aggregating a group of representative buses. The creation of hubs reduces the risk of delivering to one particular bus whose price is more volatile during a constrain than a collection of natural gas trading hub locations prices at a weighted average.
Can a hub be a source or a sink? Potentially the natural gas trading hub locations business could have a very large number of hubs. But, according to trade publications that track spot prices for next-day power, only about 20 points are actively traded. Five of the points: There are seven points in the central U. The remainder are situated in the east, and include: Although some trading occurs at all of these points, power trading is primarily concentrated among three major hubs in the east: Cinergy, Entergy and TVA, and three points in the west: Clearly power trading volumes are concentrated at a small number of locations.
But is this a negative aspect? Why is the market behaving natural gas trading hub locations this manner? And what is occurring at the remaining points? For answers to these questions, we can look to the experience of other energy commodities. For crude, petroleum products and natural gas liquids, there are only a scant number of critical market hubs, each with its own trading standards and execution tools. In the crude oil business, there are four major market natural gas trading hub locations Petroleum products utilize four: In natural gas liquids, market centers are located at: For crude, products and natural gas liquids, other points such as production facilities, refineries and storage terminals generally trade in an active location-arbitrage marketplace at market transportation differentials, relative to these major market center points.
This relative pricing structure is what makes hub-based trading work across an entire market. A futures market has only been successful at two of these trading locations - Cushing for crude oil, and the New York Harbor for petroleum products. Natural gas prices are reported daily at about points, and the commodity is traded very actively at over 30 major locations.
Yet natural gas futures have only been truly successful at the Henry Hub. Hub-based electronic trading has captured a large portion of the next-day trading market, with to trades each day in the U. When we look at successful energy trading hubs across the various commodities, six key characteristics are consistently present:. It is not necessary that a large number of transmission systems come together at a single point, although it does seem to be an advantage.
Second, a successful point requires reliable contractual standards for delivery and receipt of the energy commodity. Third, there must be transparent pricing at the point. Participants must be confident that trading is on a relatively level playing field, and that no single player nor group of players can grossly manipulate the market price. Fourth, there must be homogeneous pricing across the hub. If prices vary across the hub and there are no trading conventions to handle the situation, sellers will always seek to deliver the commodity at the cheapest location, while buyers will always seek out the most expensive point.
If left inadequately addressed, the point will probably not be actively traded. Fifth, there must be convenient tools to execute trades and aggregate transactions. This includes execution tools like electronic trading systems and futures exchanges, plus scheduling mechanisms to provide the capability to adjust a portfolio of supply to a portfolio of demand.
And finally, yet most important, there must be a critical mass of buyers and sellers that respond to the five characteristics listed above, and actively trade the market on a consistent basis. This is the definition of liquidity, which is clearly the most critical requirement of a successful trading hub. And it is the importance of liquidity natural gas trading hub locations drives markets to concentrate liquidity to as few locations as possible.
Thus, we can conclude natural gas trading hub locations the concentration of liquidity at a limited number of points is not a problem for the market. This geographic concentration of hubs functions efficiently for crude, petroleum products and natural gas liquids. Likewise, we can also conclude that each commodity is unique, requiring trading instruments and execution mechanisms designed specifically for each individual energy commodity. For example, natural gas has evolved a more diverse hub trading natural gas trading hub locations than the other energy commodities.
We believe that this diverse structure is due to a number of factors, the most important of which are: In other words, most of the physical gas supply system is targeted toward specific regional markets with unique pricing dynamics, and even more important - the cost of gas transportation and storage is high relative to the cost of gas at natural gas trading hub locations point of production. Thus, the market for gas is more localized than for the other energy commodities, resulting in a greater number of actively traded hubs and a very active location arbitrage basis and EFP market.
This also drives the gas market natural gas trading hub locations electronic trading tools, which make it easier to discover prices and execute trades at a large number of trading points.
From what we know about other energy commodities, we would expect the wholesale power market to be characterized by:. A large number of geographically diverse hubs used by the market to effect delivery of the physical commodity. A robust electronic trading market, consummating hundreds of trades each day; and. Pricing at locations distant from hub locations, based primarily on transmission cost differentials from major trading locations.
However, essentially, the wholesale power market possesses none of these characteristics. The market is confined to very few natural gas trading hub locations and arbitrage is a limited financial game frequently tied to very few hubs or the natural gas market. The top 10 to 20 players are responsible for the vast majority of the market activity.
Electronic trading beyond the mandatory California PX system is negligible, and up to two thirds of even daily trades are booked out, resulting in minimal physical deliveries. Additionally, there is a faint relationship between pricing at the major hubs and pricing at nearby non-hub delivery natural gas trading hub locations.
This schematic is more representative of the true structure of the power market. A location arbitrage market exists, but it is almost exclusively between the seven eastern points as a group, and the three western points.
There is virtually no arbitrage trading between east and west. When combined with existing and planned futures contracts also shown on this schematic, the points on this slide nearly encompass natural gas trading hub locations the entire power trading market as it exists today.
The 10 cash market hubs, combined with the six futures contracts plus one announced location at PJMand the NYMEX gas futures contract which is used by a number of traders as a surrogate for fuel costs, make up the structure of the wholesale market.
We believe that the variance between this market structure and its expectations listed previously occur mainly due to:. Unreliable and expensive transmission discourages transmission between hubs to capture pricing differentials. Unwieldy tagging rules make it difficult for hubs to be used as true physical aggregation and balancing points.
Several hubs have been defined so broadly that prices vary across the hub, defeating the requirement of homogeneous pricing across the hub; and. Primarily due to the June price spike, the number of potential counterparties at any one hub has been reduced by market withdrawals, cutbacks, and increasingly stringent credit requirements.
In other words, there is not a critical mass of players at some of the hub locations. The power market still has a long way to go before the regulatory framework and business processes have evolved to the point where a liquid, hub-based marketplace for physical power exists.
This immature state of the power market is not due to any unique physical properties of electricity, but instead has primarily natural gas trading hub locations from the lack of progress in the development of an truly open transmission network. It is an evolving market where the risk of being surprised by unforeseen events remains relatively high:. Active hubs are at risk of being refined, drying up, or fragmenting into multiple pricing points.
Long-term trades must be structured to provide an exit strategy for either side of the trade if delivery rules or trading conventions at the contractual delivery point change materially. Due to the difficulties in moving power over the transmission grid, location basis risk may be as high, or higher, than position trades in the outright commodity.
It is difficult to transport power to correct regional imbalances. The limited number of trading points today are susceptible to the domination of a very few players. Because physical power underlies only a relatively small portion of spot market trading, pricing on futures contracts may not converge with the physical spot market; putting hedging strategies in question.
The relationship natural gas trading hub locations hub prices and the value of wholesale power at adjacent points natural gas trading hub locations be volatile. This view of the power market natural gas trading hub locations not presented here to discourage trading, hub development, or long-term transactions. On the natural gas trading hub locations, the intent is to encourage market participants to manage these risks prudently by utilizing trading tools, contractual provisions and information systems that are designed to minimize these risks.
Furthermore, the intent is to encourage progress toward greater access to the transmission network by the trading community, and the development of greater standardization in business processes and contractual provisions. In Orderthe Federal Energy Regulatory Commission FERC stated its goal "to remove impediments to competition in the wholesale bulk power marketplace and to bring more efficient, lower cost power to the nation's electricity consumers.
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