Nowhere are the failings of traditional utility regulation more evident than on Long Island. The New York Public Service Commission (PSC) has raised rates for the Long Island Lighting Co. (LILCO)...
Gas Price Behavior: Gauging Links Between Hubs and Markets
relationships should be used gingerly in establishing contractual relationships, however, since they may fracture when market influences change.
In general, a strong systematic linear relationship exists between bid-week prices in Oklahoma4 and the Henry Hub, making it relatively easy to hedge risk for deliveries to a pipeline in Oklahoma using the futures contract price and an adjustment for the particulars of the linear relationship between the two price series. Not too surprisingly, the expected average relationship broke down during December 1995 and January 1996, when the actual price received in Oklahoma was much less than the expected price: $3.13/MMBtu, compared to an actual price of $2.00/MMBtu. Such experiences may motivate some companies to build reopeners into their contracts for periods when short-term price volatility increases significantly.
Beyond the Henry Hub
The price difference between locations for many commodities is equal to a relatively constant amount (sometimes called "basis") that largely represents the cost of transportation between locations. For gas, the situation is more complicated. At many locations, buyers can obtain gas from either producing or storage sites.5 Moreover, a difference in price between two hubs (em one in a primary production area and the other near a primary market area (em can represent not only the cost of transportation, but also differences in supply and demand conditions for natural gas and for pipe and storage capacity between locations.6 In fact, it is difficult to separate out any transportation cost embedded in the cost of the commodity at these locations.
Table 1 gives some idea of how the cost difference between locations changes over time. The related Figure 1 reports the difference in gas price between an area near the location where a delivery through a futures contract is made, and other locations in the United States.7 These locations lie in South Louisiana near Henry Hub, where deliveries are made through the New York Mercantile Exchange futures contract, and in Texas near Waha Hub, where deliveries occur through the Kansas City Board of Trade futures contract. Although the middle value (median) of the difference in cost is often small, the range (the difference between the maximum and minimum values) is consistently large and the difference takes on positive and negative values in several instances.
Interestingly, the average difference and the range appear smaller for the Texas location than for the Henry Hub for four of the other five outlying locations. In fact, statistical analysis suggests that for four of the five outer locations, the Texas price would be more effective for indexing a cash contract.
The highly variable difference in prices is not surprising since demand and supply conditions for the commodity and for pipeline capacity changed markedly during the 1990s (em particularly the cost of transportation, as represented by rental fees for space on pipeline systems for both short- and long-term contracts. This fact is important because the price of gas at other locations includes not only a commodity cost, but may also include some embedded transportation costs. Many shippers were able to obtain deep discounts, at times, on the cost of