The Natural Gas Hedge

When you hear the term “hedge” perhaps from a Retail Electric Provider or salesman working for an energy company or brokerage you may feel out of the know because if you are not educated in energy terms this may make no sense to you.

A hedge basically creates a position in the futures market that is exactly opposite to what you bought or sold into. This creates an equal correlation with the investment so that if the market goes up or declines you will still be at the original price you bought or sold into. In case you do not know you can sell short or buy long into the natural gas futures market. This means you can make money if the market goes down or make money if the market goes up depending on if you go short or long. That is why you can hedge in the opposite direction after buying long into natural gas futures.

The principle of hedging is simple. It is an equal and opposite position in the energy marker so that if there is a loss in one market it will be completely or as close to it as possible be made up in the other market thereby preserving the original price.

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Electric Companies Using The Short Hedge

For many retail electric companies you will find that when they are selling you an electricity rate that they actually hedge that rate by buying and hedging natural gas. Many of the power plants in Texas, for instance, have power generation plants that generate using natural gas. When electric companies buy electricity they are actually buying natural gas futures in a large part and hedging their futures contracts to protect themselves against adverse risk.

Short Hedges And Electric Rates

A common way short hedges are used is after an energy company buys an amount of natural gas futures they have an investment in that energy as inventory. They don’t actually physically have it in their own warehouse but it is in the pipes travelling from well head to well head and into the power generation plants that will be producing the electricity.

Short hedges are one of the most common forms of commercial hedging practices. The short hedge is also known as the seller’s hedge. The energy companies are protecting the inventory value of the futures contract at the time they bought it so that when they fashion the electric rate they can guarantee it to the customer at that price for a specified amount of time regardless of change in supply levels or price fluctuations. Locking in the inventory value is necessary otherwise the price quote would go up and down all day and would not be the same quote you were originally given.

When using a short hedge a general decline in prices generates profits in the futures market, which are offset by decline in the value of the physical inventory. The opposite applies when prices rise.

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Natural Gas has come up over 10% this week and this is due in a large part to the Mexico Natural Gas Pipeline explosion. The Mexican government claim that the disaster was an act of terrorism. Apparently bombers attacked at least six oil and natural-gas pipelines in Mexico’s southeastern state of Veracruz overnight. With such a drastic rise in Natural Gas there is quite a bit of money at stake. It makes you wonder who had been long on Natural Gas futures during this time? This disruption could be tracked back to an investor who has information on the people who did this. I believe it is worth looking into.

In the meantime, Texas is experiencing the brunt of it in the form of electric rates rising much higher then they were before the blast. There is not a good indicator of when this issue will be taken care of.

9/14/2007 Session Overview

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Natural Gas stays above or near the maximum storage levels

Because Natural Gas has kept itself above the historical storage levels in the last few months we see that prices are also staying below $6 MMBtu. If there hadn’t been the terrorist sabotage on the natural gas pipelines in Mexico we wold never have seen that short spike in gas prices earlier this week. Prices came up for a day or two but we are waiting to see if they will come below $6 MMBtu again. It looks like those energy traders who covered there shorts are not yet ready to sell back.

 

Natural Gas prices are way up as of today at $6.175 MMBtu. Hopefully they will again drop below $6 MMBtu but we have had a good run now for awhile and if this is the end of the drop in prices I would not be suprised. The after shocks of the pipeline explosion in Mexico is staying with us probably for the next couple of weeks.

Hurricane passes by the Gulf Coast but 15 more on their way ///

Natural Gas would have gone down today but a report put out by the University of Colorado predicts about 15 more hurricanes this year. The potential for one of these hurricanes to knock out a refinery or rig in the gulf coast is a possibility. With this fear is a frantic natural gas traders market with energy buyers and sellers speculating on high octane emotions. The volatility of the Natural Gas market is always something to watch in utter awe as the slightest thing triggers some amazing spikes in both the natural gas futures and electric prices.

Natural gas trend for the last 6 months ///

We have seen a trend since May as Natural Gas has dropped lower and lower reaching prices under $6 MMBtu. These prices have caused electric rates in Texas to be worth drooling over. Just today a large commercial facility locked in an electric rate for 6.9 cents KWh on a 12 month contract. Considering rates were right below 10 cents kwh in the not so distant past we would be quick to jump on this price if we had an opening in our energy contract to do so.