Overview of natural gas market

The natural gas market is one of the largest, most established energy markets.

1. Natural gas plays a central role in the energy industry
• Cleaner burning than coal, less expensive than petroleum, limited carbon emissions, operational flexibility and efficiency.
• Almost all of fossil-fuel-based power plants built in USA since 1990 can burn natural gas ==> strong link between power and natural gas prices.
• It is prohibitively expensive to replace existing infrastructures of gas pipelines ==> Heating and electricity in North America highly depend on natural gas.
2. Composition of natural gas
• Nonrenewable fossil fuel, colorless, odorless gas
• Primary composition: methane (CH4)
• Other contained hydrocarbons such as ethane (C2H6), propane (C3H8), and butane (C4H10)
• 'Dry' ==> Almost pure methane; 'Wet' ==> contains substantial amounts of other hydrocarbons.
3. Trading unit of natural gas
• Natural gas is commonly traded in units of heat energy like British Thermal Units (BTUs), rather than in units of volume (like cubic feet)
• One cubic foot of dry natural gas contains approximately 1,000 BTUs
• 1 MMBTUs (million BTUs) = 1,000,000 BTUs ==> 1 BCF (billion cubic feet) natural gas contains about 1 million MMBTUs
• Natural gas are typically sold to consumers in units of therms. 1 therm = 100,000 BTUs = 0.1 MMBTUs
4. Heat density
• One gallon (=0.13 cubic feet) gasoline contains 124,000BTU, the amount of heat contained in 100 cubic feet natural gas ==> 1 cf gasoline ~ 770 cf natural gas
• 1 cf gasoline ~ 3 cf natural gas (under 250 atmosphere pressure)
• 1 gallon gasoline ~ 1.5 gallon natural gas (supercooled liquid
5. Transportation
• Natural gas is transported through pipelines, instead of pressurized container because it contains relatively low amount of energy per volume
• Natural can also be cooled to -260 F (liquefaction) to be transported in liquid form, suitable for the cases where building pipelines is impractical, such as transportation over oceans.
6. Pipeline Transportation
• Hub --- the location where two or more pipelines connect
• Citygate --- a special type of hub where interstate pipelines connect to local distribution networks.
7. Basis trading
• To trade natural gas, traders usually enter into two trades: (1) a futures trade at the Henry Hub; (2) a basis swap that exchanges the Henry Hub exposure for an exposure at some other location.
• Natural gas futures (Henry Hub contracts) are standardized, liquid, and traded at exchange
8. Trading types
   Since natural gas prices show strong seasonality, it is not common for traders to play directional bet on the entire natural gas market. Generally, traders speculate on one aspect of the natural gas market by entering into spread trades, where a trader benefits from the price difference between securities by buying one and selling another.
• Location spreads: price difference between two locations
• Heat rates: speculate the relation between natural gas and electricity prices
• Time spreads: speculate on the price difference between periods of high and low demand
• Swing trades: traders use their gas storage capabilities to play the buy-low-sell-high games.
9. Spot vs forward markets
• Natural gas spot prices are heavily influenced by weather
• Natural gas forward prices are seasonally cyclical
• The spot market is substantially more volatile than the forward market
• Natural gas futures prices are not linked to spot prices and carrying costs in the same way that the futures prices for stocks, bonds, and gold are linked to their spot prices.