Cold winter could mean return to high regional basis prices

By Ben Straus, U.S. Energy Services | August 29, 2014

The leaves on the trees are still green but with the settlement of the September New York Mercantile Exchange natural gas futures contract, only the October futures contract remains to be settled before the end of summer. With winter looming around the corner, sparing some time to learn a few lessons from the prior year and plan for the upcoming heating season is a prudent course. Looking beyond NYMEX pricing to regional basis values as a potential target for hedging could be a possible component to winter risk management strategy.

While last winter reiterated the important link between weather and demand for natural gas for heating, the relatively limited accuracy of long-term weather forecasts renders the weather as a mostly random variable in terms of strategic planning. While cold weather can’t easily be predicted this far from the heating season, the cold weather of last year did deliver some lessons about the state of the market and regional risks. The incessant cold across much of the Upper Midwest and Northeast of the U.S. highlighted the relationship between natural gas storage and regional price volatility. As inventories were rapidly depleted from December through January, the balance between storage inventory and transported gas from outside the market area began to shift. With limited remaining storage reserves, demand in those regions that were pummeled by cold was increasingly satisfied by gas transported on interstate pipelines and prices rose to find levels that would either justify additional deliveries from generally uneconomic sources of supply or by rationing demand. When deliverability was maxed out, regional prices rose to staggering levels. For example, prices in Chicago traded at more than $25 per MMBtu on three separate occasions this past winter, while the well-supplied Henry Hub in Louisiana never topped $10 per MMBtu.

The differential between the NYMEX and regional prices is typically referred to as the basis price in the natural gas industry and is a hedge-able component of the overall natural gas price. With storage inventory levels lagging behind the five year average level as well as the inventory level of 2013, analysts were fairly confident that entering the upcoming winter, stocks would remain behind historical norms. Although production levels are running 2.5 Bcf per day stronger than the prior year and may soften the bite of early and late winter demand, the reality is that another winter with extended cold could mean a return to high regional basis prices as storage inventories are more susceptible to a spike in consumption. By fixing the basis price for some portion of the gas supply portfolio, the end-user loses out if the differential between the regional index price and the NYMEX futures contract falls but benefits if the spread widens. While basis values have risen for the upcoming winter, based on historical values, the difference between the historical high and the historical low for realized spot basis over the last five years current levels may still argue in favor of considering a basis hedge.