September 8, 2021
What in the Basis Is Going On?
By Jeff Bolyard, Vice President, Commodity Strategy
This post will be featured in our upcoming September 2021 Monthly Monitor, which includes articles and analysis for the natural gas, electric, crude oil, and sustainability markets. To sign up for the Monthly Monitor distribution list, click here. To download past issues, click here.
The term “Basis Differential” or “Basis” is used by those within the natural gas industry as one of several components to price the commodity to a specific area of the country. Outside the inner circle of those that buy and sell it every day, the term can be confusing. In simpler terms, natural gas Basis is the difference in price for a particular region of the country as compared to the benchmark for the U.S., which is the Henry Hub located in Erath, Louisiana. Henry Hub is the official delivery location for futures contracts on the New York Mercantile Exchange (NYMEX).
This differential in price to the Henry Hub for each region considers three major considerations which determine the premium or discount to the Henry Hub price: 1) regional market conditions 2) transportation costs and 3) pipeline capacity.
In January 2010, prior to the prolific development of natural gas shale production, the seven major shale areas produced an average of 22.7 Bcf/day (EIA data), with Henry Hub at the nexus of interstate and intrastate pipelines that connected significant gas volumes of production with various markets across the country. Fast forward to July 2021, when these same seven shale areas produced an average of 85.5 Bcf/day.
So how did the gas market price with these major increases in supply from areas that do not physically connect with the Henry Hub?
It reacted, increasing or decreasing the Basis differential to the Henry Hub to account for the change in extra production in the region (market conditions), as well as the price to move it to a market via one of the new infrastructure projects built (transportation costs) to deal with this production. When the amount of production exceeds the ability of the infrastructure (pipeline capacity) to get the gas out, the Basis becomes a discount, or negative, to the price at the Henry Hub.
A good example of where the Basis differential was at a significant discount was seen in the West Texas Permian, when natural gas production increased four-fold since 2010 but takeaway pipeline capacity held the excess production captive, forcing Basis to be a significant discount to the Henry Hub price (gray area in chart below). As infrastructure was added to relieve excess production, Basis pricing increased.
In 2019, Gulf Coast Express, a new 1.9 Bcf/day pipeline started flowing Permian supply out of the region, (dashed green circle). In January 2021, the Permian Highway Pipeline also opened, adding another 2.1 Bcf/d of takeaway capacity out of the region (dashed yellow circle), shrinking the Henry Hub differential yet again.
The opposite effect is occurring in Southern California, where the SoCal city gate Basis premium to the Henry Hub (blue area in chart below) is significant. Reasons for these significant Basis premiums include hot weather, wildfires, and severe drought, which have such limited hydro generation in the state that Hyatt Power Plant, one of the largest hydro facilities in the U.S., recently closed for the first time since opening in 1967 due to lack of water.
When one fuel source is removed from the generation stack, something else must be added in to meet demand. Right now, the California market is looking to natural gas to fill the gaps. With limited gas pipeline capacity available to meet peak demand, significant multi-dollar spikes in Basis can be seen monthly, as well as in the forward Basis market over the next year, as no solution is yet in place to correct the issue.
Several areas of the country have emerged as significant Basis premium risk or discount opportunities that have been impacted by regional market conditions. These include the growth of either supply or demand, abnormal weather, storage levels, or even changes in law; increased transportation costs caused by new infrastructure or new rate filings; and pipeline capacity that is either in excess of production or projects intended to meet existing or growing demand but have been significantly delayed for various reasons (permitting, legal challenges), pushing the implementation date back or even causing cancellation of a project.
Edison Energy monitors over 60 different Basis regions to help clients manage this increasingly volatile cost component. Please reach to your account manager with any questions you have about Basis risk.