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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 introduced 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 of 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 , 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 and markets to both reduce their exposure to risks inherent 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 price 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 forces; 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 gas 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 at 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, the price, the amount of natural gas to be sold usually expressed in a volume per day , the receipt and delivery point, the tenure of the contract usually expressed in number of days, beginning on a specified day , and other terms and conditions. The 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 of 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 players 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 markets: 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 market 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 price , etc.
Financial natural gas markets may also be used by market 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 with 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 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, and 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.