Natural Gas Price Volatility in 2015 & Beyond - Webinar

Q&A's:

The following questions were asked via chat by attendees, but we didn't have time to respond during the live Q&A portion of the webinar. NGI's Pat Rau provides answers below. Be sure to listen to the full webinar for Pat's response to these questions asked during the webinar: (1) Do you foresee any other changes to your Spot Market table? (2) How confident are you in your forecast that takeaway capacity out of the Appalachia will be 38 Bcf/d? (3) Any idea on how much processing capacity is coming to the Marcellus & Utica?

Q: How important is ample infrastructure to Marcellus becoming a hub and a replacement for Henry Hub?

A: We think it would be extremely important, although we do not believe the Marcellus will in fact take over for the Henry Hub. Having enough gathering, processing, and pipeline takeaway capacity in place in the Appalachia would likely cause basis differentials within the region to move more uniformly, and likely converge more closely together, meaning that a single hub price would be more representative of all production in the region. Also, more infrastructure would help promote trading liquidity in the area, which we believe is the main requirement in having any Appalachia price point pose a challenge to the Henry Hub.

Q: If Appalachia were to over take the Henry Hub on which pipeline would the new settlement point likely be on?

A: If it were on a pipeline, it would most likely be either Columbia Gas Transmission (TCO) or Dominion Transmission (Dominion South). Both of these pipelines traverse the major unconventional production areas in the Appalachia, have significant storage capacity behind their systems, and show good spot market trading liquidity. Columbia has a bit more of a diverse geographical reach, while Dominion is the “traditional” pricing point for Appalachia production. However, we believe an actual hub where multiple pipelines come together would be more appropriate, since that lessens the chance that any major constraints behind any one individual pipeline would curtail service at the Appalachia settlement point. The Leidy Hub in central PA is one candidate, but trading liquidity here is low. The Lebanon Hub in SW Ohio is gaining liquidity, but that is some distance away from the producing regions. Perhaps a new hub will emerge in the Appalachia in the future, such as at Clarington, OH with several new pipeline projects slated to move local production that point. But short of there being an actual liquid hub, we would expect any new settlement point would like be located along either TCO or Dominion South.

Q: Should the relationship between spot prices and derivatives be treated the same with respect to Henry Hub and Appalachia, given the differences in volatility?

A: Since we don’t trade physical or financial products at NGI, we cannot give you an answer based on direct experience. However, from a purely theoretical standpoint, we’d have to say no, they should not be treated exactly the same. The relationship between spot prices and the futures contract should be different at the Henry Hub from that in the Appalachia, because of the presence of arbitrage. Every month, the Henry Hub cash market and futures market should converge, otherwise there would be an opportunity to take advantage of that spread. There is no futures contract in the Appalachia, so there isn’t that extra financial presence to keep Appalachia cash prices in line, so to speak.

Volatility is a key determinant behind the value of both put and call options, so the rising volatility in Appalachia spot market prices should push put and call premiums higher in the Appalachia than at the Henry Hub, everything else being equal. The same should hold true for the bid/ask spread for swaps in the Appalachia, since the increasing spot market volatility there means derivative dealers will likely require extra compensation for taking on risk in this area.

Q: What impact will the Dawn Hub have on pricing given its volatility in February?

A: We’d certainly expect the Dawn Hub will have an increased effect on pricing, but probably more so because of upcoming pipeline takeaway capacity additions from the Marcellus & Utica into Dawn than from any recent winter volatility. The continuing reversal of Rockies Express, and the potential for three new pipelines that could ultimately serve Dawn would have a much more lasting impact on pricing both in the Appalachia and at Dawn, in our view.