Higher and more volatile natural gas prices have created opportunities for some and challenges for others. Hedging became more popular with producers last year as they attempted to lock in higher prices. Meanwhile, gas buyers tangled with a difficult market while wondering what is to come.
“The volatility is a challenge for all market participants,” Griff Jones, CEO of Houston-based marketer Eagle Energy Partners, told NGI. The step-change in prices has provided an education to many, but there will be more to learn as liquefied natural gas (LNG), pipeline and storage development continue and the market evolves.
Higher gas prices have obviously been a boon to producers, particularly to those who locked them in over the coming summer months. “I know the producers that hardly did any hedging years ago are doing some; the producers who were doing a little bit are doing more, and there are some real sophisticated ones out there that do quite a bit of hedging,” Jones said. Driving this, in part, are increased costs for drilling and asset acquisitions. “I think it’s caused [producers] to be more disciplined about locking in future prices,” Jones said. “But even that creates a whole new realm of issues that they have to deal with, specifically, margin calls.” He said producers are having to structure deals carefully to avoid getting blindsided in a more volatile market.
Jones said he has seen an increase in the level of sophistication with which producers approach hedging activities, and they have more resources in the marketplace on which to draw as banks, brokerages and others are providing more information on their commodity price outlooks than they did in the past. This, combined with liquidity on the Nymex, make hedging the commodity easy compared to hedging basis risk, an area where Jones said the market has room for improvement.
“I still think producers are struggling with locational differences and basis. I think the basis moves have surprised a lot of the producers out there in general. When you get into basis there is a lack of liquidity in the marketplace; there is less information, which means it’s harder to educate yourself about what’s going on,” Jones said. He pointed to last year’s basis differentials in the Midcontinent and Canada as evidence of a more complicated market. “We’ve seen a lot of people surprised by Canadian basis movements, and there’s been a general sentiment of asking why the Midcontinent basis has been blowing out so large.”
And a lack of liquidity in basis markets has kept producers from finding all of the tools they would like to have to manage basis. “For example, if you’re on a pipeline that doesn’t have a liquid basis market, you may have to trade another basis market that you think is going to emulate where your location is, and I think that’s caused a lot of confusion among people who are wishing there was more liquidity,” Jones said.
Still, he said that some market fundamentals indicate to him that producers will be able to look forward to a strong price environment for some time to come. “Fundamentally, we’re seeing bigger depletion curves and gas-fired generation becoming more prevalent and more on the margin. A hot summer could have a pretty big effect on the supply picture.”
While producers are taking greater advantage of financial tools to manage price risk, there are likely a good number of local distribution companies (LDCs) who wish they could do the same. “Every state PUC [public utility commission] probably has a different view on what their LDCs should be doing [to manage price risk]. In general, we don’t see many [PUCs] being very proactive in trying to help manage these prices.”
Price caps are not the answer, Jones said. “I think it would be nice to let market forces work the way they should. If regulators feel like they need to have a better handle on long-term prices, they should free up the reins a little bit to allow their specific entities…to go out there and implement hedging programs.”
While LNG importation could be a stabilizing force in gas markets longer term, the promise of more LNG is creating uncertainty for the time being. “I think there is still a question as to how much LNG is actually going to show up,” Jones said. “There have been few new sites actually approved versus all the ones that have been announced, and I think market participants are still trying to figure out which ones are real and which ones are not. There are a lot of people intrigued by the potential effects of LNG, but I don’t think anyone really understands what those ultimate effects are going to be.”
On the gas demand side, Jones said that a lot of the markets with which Eagle Energy deals don’t particularly want to deal with the operational uncertainty engendered in ship-based gas delivery. “Most markets just want to buy flowing natural gas,” he said. “They want to buy it in Chicago or in New York or in Atlanta. They don’t necessarily want to buy it at the tailgate of some plant and have a lot of force majeure contract language that can be introduced to them. I think there are a lot of contracting issues that need to be worked out on the LNG side, and I think there needs to be a little bit more surety that this LNG is going to be coming here.”
Jones is one of four panelists who will speak on the evolution of gas trading at GasMart 2006 May 3-5 in Denver. For more information, visit https://gasmart.com/.
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