Natural Gas Trading

Natural gas is marketed on a number of trading platforms that are located at "market hubs" across North America. Natural gas prices are established via electronic trading systems and based on the market forces of supply and demand.

Trading Platforms

There are two distinct markets for natural gas: the spot market where natural gas is bought and sold on the daily market, and the futures market that involves buying and selling natural gas in advance under contracts with terms out at least one month.

Spot and future prices are established through the interaction of supply and demand on various trading platforms, such as the New York Mercantile Exchange (NYMEX) in the U.S. or the Natural Gas Exchange (ICE NGX) in Alberta. Natural gas prices in North America are primarily determined by traders entering into NYMEX contracts, with prices being established through offers (to sell) and bids (to buy) on future months’ delivery commitments.

Alberta’s gas prices are based on NYMEX contract prices that have been discounted to reflect such factors as the province’s supply basin, foreign exchange rates between Canada and the U.S., and the conversion process from MMBtu to gigajoules (GJs). The daily spot price is determined by the ICE NGX trading system and is referred to as the “AECO C/NIT” spot price. This price has become one of North America’s leading price-setting benchmarks and influences the value of future term contracts. The majority of natural gas is sold into the daily spot or cash market where the delivery period is for one day.

Natural gas trading may be categorized as physical trading that involves buying and selling the physical commodity, and financial trading in which buyers and sellers do not take physical delivery of the natural gas. Financial trading involves derivatives and sophisticated financial instruments and is used to provide a hedge against the risk of price movement or to generate profits by taking advantage of price differentials.

Reference Pricing

Natural gas prices are quoted in relation to a physical location, which is usually a natural gas storage facility or a transfer point on a natural gas pipeline. Natural gas prices are determined daily for physical receipt, or traded for later receipts via the futures market.

The most commonly quoted price for natural gas in the U.S. is the “Henry Hub price”, which is based on gas deliveries to the Henry Hub storage facility in Louisiana. Deliveries to other locations in the U.S. are valued at these locations based on a pricing differential between the delivery points. This “basis differential” is mainly comprised of transportation costs plus a premium or discount as compared to other competitive energy supplies.

The AECO Hub gas storage facility in southern Alberta is one of the largest natural gas hubs in North America, with its substantial production and storage capability and extensive network of export pipelines. This Hub serves as the reference point for establishing the NOVA Inventory Transfer, (“AB-NIT”) price for users of the transmission pipelines in the province. Gas prices are often quoted in terms of the basis differential between AECO Hub prices and Henry Hub prices.

The AECO Hub has historically been one of the lowest cost locations in North America for purchasing natural gas, as this province is a supply basin and there is a cost for transporting Alberta’s gas supplies to markets across North America. Other commonly quoted reference points for natural gas prices in Canada are the natural gas storage facility at Dawn, Ontario and the pipeline transfer point at Sumas, B.C.

Natural gas suppliers in Alberta purchase their gas supplies directly from gas producers or through trading platforms, such as the NGX, for eventual sale to consumers. Retail gas prices include distribution charges that cover the fixed costs of infrastructure to deliver the natural gas to the consumer, as well as other charges to recover the retailer’s operating and administrative expenses.

Market-driven Prices

The market forces of supply and demand have been the main determinant in natural gas pricing and influence many decisions made in the natural gas industry, such as whether to produce, buy or sell natural gas.

Supply and demand forces may impact both short-term and long-term natural gas prices. For example, sudden cold temperatures or production disruptions from hurricanes may cause daily price fluctuations and such factors as population growth, economic conditions and government legislation may heavily influence longer term prices.

Supply Fundamentals

Pipeline capacity. Infrastructure for transmission and gathering pipelines limits the volume of natural gas that may be transported from producing regions to consuming regions. This infrastructure will generally expand to meet future demand.

Gas drilling rates. The amount of natural gas produced from associated and non-associated sources may be controlled to some extent by the producers. Technological advances over the years, such as horizontal drilling, have had a major impact on drilling activities and production levels. Drilling rates and gas prices tend to result in a circular process for market prices. Low gas supplies relative to demand will cause prices to rise, which provides incentives for producers to increase their capital expenditures and drilling activities. A prolonged increase in gas supply levels will eventually lead to a softening of prices, which starts the cycle over again.

Gas storage supply. Underground gas storage facilities are primarily used to meet peak seasonal demands. This is achieved by injecting natural gas into storage during periods of low demand and withdrawing from storage to meet peak winter demands. Producers and marketers may also utilize gas storage for hedging activities by storing and selling the gas to take advantage of price differentials.

Natural phenomena. Natural phenomena, such as hurricanes and tornadoes, may have significant impacts on natural gas production and supply. For instance, when hurricanes approach the Gulf of Mexico, offshore natural gas platforms may be shut down as workers evacuate, thereby lowering overall production levels. Hurricanes may also cause severe destruction to onshore production facilities, which will further curtail supply levels.

Technical Issues. Malfunctions of natural gas pipelines or related equipment may temporarily disrupt pipeline flows and decrease the supply availability to certain markets. Conversely, technical developments in pipeline and drilling methods may generate increased gas supplies.

Imports and Exports. Natural gas imports increase the availability of supplies to certain regions, whereas the purpose of natural gas exports is to sell excess supplies. Major exporting systems that connect regions across North America enable the U.S to import approximately 40% of their natural gas supplies from Alberta and another 30% are from other Canadian provinces.

Demand Fundamentals

Weather. Seasonal weather conditions have a major impact on natural gas demand. Colder temperatures (measured in degree days) in the winter period will increase the heating demand for residential and commercial consumers. During the warmest summer months of July and August, natural gas is required to generate additional power to meet increased cooling demands in the highly populated areas of the U.S.

Hurricanes. The impact of hurricanes may reduce the demand for natural gas. For example, the destruction of power lines due to hurricane activity may interrupt the operations of electricity generating facilities that utilize natural gas, thereby reducing the consumption of natural gas at these locations.

Alternative energy sources. Supply and demand dynamics in the marketplace determine the short-term price of natural gas. However, this process may work in reverse if the price of natural gas impacts the demand levels for certain consumers. This is particularly true for those consumers who have the ability to switch to different energy sources, such as industrial and electric generation facilities. When gas prices are extremely high, for example, electric generating facilities may switch their energy source from natural gas to cheaper coal or fuel oil. If the overall amount of fuel switching is substantial, the resulting decrease in natural gas demand will put downward pressure on gas prices.

Demographics. Changing demographics may affect the demand for natural gas, especially for core residential customers. In the U.S., population movements to warmer climates would normally result in decreased heating demands in the winter but increased cooling demands in the summer.

Economic conditions. Economic growth or contraction may have a considerable effect on the demand for natural gas, particularly for industrial consumers and, to a lesser extent, commercial customers. When the economy is growing and thriving, output from the industrial sectors generally increases. When the economy is experiencing a recession, however, output from the industrial sector declines and, in turn, reduces the natural gas requirements for this sector.

Gas storage demand. Natural gas storage levels may have a significant impact on demand and market prices throughout the year. When storage levels are low, a signal is sent to the market indicating the need for additional storage injections. Conversely, when storage levels are high, storage injections will tend to drop off and market prices will generally decline in response to greater supply availability.

Natural gas exports. Export requirements are another source of demand for producing regions. As an example, natural gas produced in North America is exported to other countries, such as Japan, due to demand requirements that cannot be fully met based on the production of natural gas within these countries.