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Gas Price Behavior: Gauging Links Between Hubs and Markets

Fortnightly Magazine - April 1 1996

pipeline space, because excess pipeline capacity was available to many markets. The amount of excess capacity also varied over time, as demand shifted in response to changes in the weather. Then, in 1993, the industry switched to a new rate-setting method (straight fixed-variable) that calculated rental fees for first rights to space (firm transportation service) according to the fixed capital costs of pipeline systems. After 1993, companies gained the right to reduce the cost of transportation through a capacity-release market, where firms release and sublet rights to unused pipeline space.

Implications

for Trading Centers

The development of a second futures market for delivery at the Waha Hub in West Texas and plans for additional futures markets in locations with access to Western and Canadian markets are motivated, in part, by the large price volatility shown between locations. This variability also supports the development of market hubs as trading centers.

Past analysis has identified several distinguishable markets for natural gas in the United States, not one.8 In fact, the formation of market hubs as trading centers was inspired, in part, by the desire to reduce informational and operational inefficiencies. Hubs organize trading activity at locations where prices on gas, storage, pipeline, and other services are available to all participants in the hub market, and where daily trading might be active enough to provide liquid markets. In fact, as trading at hubs substitutes for transporting or trading gas between locations, the amount of gas that remains subject to locational risk actually declines.

Companies with rights to hub services are well-positioned to trade rights to gas and to transportation and storage capacity. As their current and expected future requirements vary from planned amounts, hubs could provide these companies with a means of getting back into balance or of transferring an unneeded service to another hub participant for a fee. This type of activity encourages the development of forward markets for gas.

Moreover, futures markets could face competition were many hubs to develop into liquid forward markets (i.e., markets where bid prices are close to offer prices). Participants could fix prices through a liquid forward contract rather than attempting to fix price through a combination of a liquid futures contract(s) and an expected spot contract(s) for some future time period in which, as previously pointed out, the futures contract and the spot contract trade at different times for the same delivery period.

Understanding price behavior provides strategic value to distribution companies and other large users of natural gas. Active involvement at a hub can serve as a core activity for a company developing strategic approaches to the use of price and other market information.

Finally, active hubs with broad industry participation can provide the same needs for coordination and information provided by alliances among local distribution companies. The difference is that coordination and information are supported by active, open, and relatively transparent contracting in markets, rather than by relatively fragile agreements between the members of an alliance. t

John Herbert is a senior economist at the Energy Information Administration, and an adjunct professor of statistics at