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.

More about natural gas

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.

More about natural gas

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.

Oil and gas futures cam down but not natural gas

Oil and gasoline futures came down substantially on Thursday as people realized the tropical storms reaching the gulf had died down enough to not be considered dangerous. There is now no fear of them hitting the refineries as they have been down graded below the tropical storm levels they were at. 

Investors have started to pay more attention to the struggling economy and the falling stock market rather then where oil and gas futures are going.

Natural gas ended higher even though large surpluses were reported in the storage report

Natural Gas futures ended higher after several ups and downs despite the government surplus report showing a large inventory of Natural Gas in the ground. The Natural Gas inventories have been growing larger then expected and as an energy trader you would expect this would cause energy futures to start coming back down but this has not happened yet.

Tropical storm Erin appeared spared most of the Gulf Coast oil and gas infrastructure.  Tropical storm Dean is expected to pass to the south of the Gulf, making landfall on Mexico’s Yucatan Peninsula.

Natural gas has fallen about the same as stock prices have taken a plunge.

 Is there some type of correlation with the financials market? It certainly makes you think. We see that Natural Gas has taken a nose dive down. Now let’s look at a stock exchange index and compare.  Whenever you seen the stock market take a harsh move down it would probably be an indicator of what Natural Gas may doing as well.

NYMEX Natural Gas Futures Chart

Now take a look at the S & P 500 over the same time frame. The nose dive spurred on Natural Gas to do the same or so it would appear.

S&P 500 Index Chart

Natural Gas Prices

Gas rose a fraction today

 Natural Gas Prices today rose a fraction higher but not enough to cause a stir. Yesterday we saw them close at $6.20 MMBtu and today they are at $6.29 MMBtu. This small move has seen the markets remain flat across sectors that correlate strongly with this carbon fuel.

Flat market with Electricity in the state of Texas

Texas electricity has maintained a flat market today with this news and could possibly see electric rates drop tomorrow with no new signs of tropical storms in sight and summer heat remaining around the same temperature we have been at.

Texas has the wettest year on record

One possible cause for lower then usual summer temperatures could be to the fact that rain has kept the temp down enough that Texans do not turn up the air conditioning quite as high. According to recent news Texas has had the wettest year on record starting with the first 7 months of the year. This has been the first no drought year in a decade.

Weather pattern reaches outside of Texas

This wet weather is not just affecting Texas but is similar all around the bordering states and into the carribean. Electricity Rates and Natural Gas continue to cut those who rely on them a break adding needed dollars to the bottom line. Let’s hope the weather and the energy rates remain low for a few more months.

A gradual trend down in the settlement price, that isn’t what they said would happen?

The Natural Gas Price in the United States has shown a gradual trend down over the last 2 months. It seems quite strange to many as they have been told by the electricity providers to hurry and sign up before the summer because natural gas will be in high demand as people start to turn on their air conditioning and using up all that electricity.

Has the summer caused a spike in Natural Gas Prices?

The summer has had the opposite effect. There has been more then enough natural gas in storage to meet with the demand. This surplus has caused energy traders to rethink things this year as the natural gas price has been trading low over the last two months. In Texas we have a 90% correlation with natural gas in terms of electricity and so we have seen electricity prices go from the high 9’s down to below 7 cents per kwh the last 2 months. Many people are scratching their heads after being told to sign up on the 9 cent electric rate when now in the dead heat of summer we are seeing rates as low as 7 cents a kwh.

Did the electric provider at TXU lie to me?

No they didn’t lie they just speculated on what natural gas usually does every year. During the summer you see some superficial spikes up when people turn on their air conditioners. This then effects the storage supply’s of natuarl gas so when these air conditioning spikes occur they lose that storage necessary to cover peak demand times. This comes very close to causing a shortage and so the price goes up. So did they lie to you? No you can’t call it that. Sure they wnted your sale but they were actually giving you a decent guess as to what might happen. Are sales people dishonest? Many times yes and they can sometimes offer you more information but this time we can’t say they lied.

Henry Hub is the pricing point for natural gas futures contracts traded on the New York Mercantile Exchange (NYMEX). It is a point on the natural gas pipeline system in Erath, Louisiana. It is owned by Sabine Pipe Line LLC.

It interconnects with nine interstate and four intrastate pipelines: Acadian, Columbia Gulf Transmission, Gulf South Pipeline, Bridgeline, NGPL, Sea Robin, Southern Natural Pipeline, Texas Gas Transmission, Transcontinental Pipeline, Trunkline Pipeline, Jefferson Island, and Sabine. The two compressor stations can compress 520,000 decatherm/d (6.3 GW) . The transportation capacity is 1.8 billion ft³/d (bcf) (590 m³/s) (20.4 GW) (Sabine Pipe Line, LLC, 2000).

Spot and future prices set at Henry Hub are denominated in $/mmbtu (millions of British Thermal Units) and are generally seen to be the primary price set for the North American natural gas market. North American unregulated wellhead and burnertip natural gas prices are closely correlated to those set at Henry Hub.