February 21, 2018
NYMEX vs. Index Natural Gas Contracts and Why It Matters
By Edison Energy
One of the most important decisions an end-user will face when entering a natural gas contract is determining what pricing product best suits their goals and operational needs. Several different pricing products are available in the market, the most common of which are NYMEX and Index Natural Gas Contracts.
While both are monthly-priced, variable products, understanding the benefits/risks of each will ensure your organization is entering into the best contract possible.
NYMEX + Contract (or Basis Contract)
A NYMEX + contract has two primary cost components: NYMEX and Basis. NYMEX is the cost of the commodity, or the actual gas molecules, and is based on the price of gas at a set point:
Henry Hub, Louisiana.
Basis is the regional differential to the NYMEX Henry Hub price and can be an additional adder or discount to the NYMEX price. Basis varies widely throughout the country and is driven by regional supply and demand factors. Basis could be offered at a discount in oversupplied areas without a market, or, at a premium in high-demand areas with limited access to supply. Basis is inclusive of delivery charges, delivery taxes, fuel and supplier margin and continually fluctuates with supply and demand dynamics in the area.
With this structure, the Basis component is locked in at a fixed rate to eliminate the monthly regional price risk, while the NYMEX component floats monthly (NYMEX settles monthly three business days prior to the end of the month for gas delivery the following month; Ex – 1/29/18 NYMEX settled at $3.631/MMBtu for Feb18.) Typically, a specific contract quantity is required when locking basis.
Index + Contract
An Index contract structure is determined monthly, like the NYMEX, but is based on a specific region of the country (not Henry Hub, Louisiana). It is usually stated as a referenced published Index, plus an adder.
There are dozens of liquidly traded, regional index points which represent the cost of gas delivered into different market areas. The Index price can vary substantially both monthly and seasonally based on supply and demand factors in that region. Weather conditions and available pipeline capacity often determine the volatility of an Index point. The monthly Index price is published the second business day of the month, after the decision of how much gas to flow has been determined.
One benefit of an Index structure is that an end-user typically has the flexibility to adjust monthly contract volumes before the Index being determined. Volume flexibility can be an advantage to end-users that do not have a predictable load or usage profile in advance. An Index contract provides assurance that firm supply will be available, without entering into an agreement for more supply than what is required by a facility.
Figure A. Comparison of Index and Basis contracts on various factors
Risks & Benefits
A NYMEX contract provides price stability, as it is not exposed to regional risk like an Index structure. NYMEX pricing is influenced mainly from supply and demand volatility from a national perspective. In today’s gas market — with prolific deposits of gas recently discovered in the Appalachian, Texas, and Dakota regions — NYMEX pricing has been relatively low, with limited prolonged volatility.
Figure B. NYMEX Settle vs. Dominion Index History
An Index contract is subject to any constraint that limits gas into or out of an area. An example of this can be found in Dominion Appalachia Index (Figure B), which covers the eastern Ohio, western Pennsylvania and West Virginia markets.
This area has been inundated by gas from the Marcellus/Utica shale plays, providing the region with supply that greatly exceeded local demand. The issue was compounded by the lack of existing pipeline infrastructure; the ability to move gas out of the region was severely limited, and excess supply became stranded in the tri-state region.
As a result, the Dominion monthly Index and forward Basis both decreased substantially. The market adjusted to alleviate the supply glut with the approval of a new pipeline, Rover, which would move gas out of the region to higher demand areas.
With new markets forthcoming, forward Dominion Basis increased from historic lows and the monthly Index showed strength as well. However, in 2017, the pipeline was forced to stop construction due to environmental concerns. Once approval was granted for Rover to resume construction, the Index bounced back yet again, more than doubling in price (Oct 17 $1.10 – Nov 17 $2.50). As indicated in Figure A, there can be extreme volatility in regional pricing.
While there is more risk entering into an Index deal, an end-user could have benefited greatly while supply was captive and the market was depressed. However, In the Northeast U.S., where pipeline constraints are prevalent and there is not enough supply to meet regional demand in the winter, pricing could increase by 100 percent or more.
In today’s complex energy environment, smart energy management is vital for your organization’s success. The key is to understand the risks involved with each pricing product and to choose the solution that best fits organizational goals, operational needs and geographical location of the facility. To find out more about how to get independent, comprehensive, expert and data-driven advice on your natural gas supply management, contact Edison Energy today.