Public Utilities

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Markets, Hubs, Trading Places, and Capacity
Release Markets by John H. Herbert
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Summary
This presentation describes new trading
environments for natural gas commodity and
transportation services. It also identifies the
factors that influenced the development of these
environments. Actual examples are provided that
show how these and other developments can be used
to fix the price of gas and to provide other
commercial benefits.
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A Lot of Interesting Market Developments
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West Texas Market Centers Interplay With North
and East Texas and Loiusiana Market Centers
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Streamline Auction Market Volume Traded
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Energy Exchange Auction Market -Intra-Alberta
(Number of Trades)
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Price Risk and Market Centers and Hubs

• How Much Price Risk or Volatility is There?
• A Lot!

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Volatilities - NYMEX Natural Gas Futures Market,
November 1996 To May 1997

• Most commodities average volatilities below 20

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Why Is There So Much Short Term Price Risk?
Weather events - there is no commodity in which
the demand varies more in the short term Other
Reasons

• New Inventory Management Strategies
• Fuller Use of Existing Pipeline Capacity

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Responses To Short Term Price Volatility

• Flexibility in Contracting and in Services -
  Market Hubs and Centers

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Encouraging Trade

• Market Hub, Market Centers, and Auction Markets
  Should Encourage Trade Between Gas Sellers and
  Buyers Where a Buyer can be a Seller and a Seller
  can be a Buyer

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Encouraging Exchanges

• Capacity Release Markets Should Also Encourage
  Exchanges. An Increase in the Volume of Capacity
  Releases Could Indicate an Increase in the Number
  of Exchanges of the Commodity.

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Encouraging Exchanges

• An Increase in the Number of Capacity Exchanges
  Could Indicate a Decline in the Subscription for
  Firm Capacity. This Would Exacerbate the
  Capacity Turnback Problem.

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Constant Trading - Firm Capacity

• Constant Trading Works Well as Long as a Company
  Has Firm Capacity

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Constant Trading - Pipe Capacity

• Constant Trading can Work even Better if Company
  Trades Pipe Capacity the Same Way it Trades the
  Commodity

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Constant Trading - Release Capacity

• Constant Trading Works Best for a Company When
  the Price of Release Capacity is Independent of
  the Price of Commodity

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Constant Trading Can Fix or Hedge Price

• 1. Determine average requirements during some
  period.
• 2. Determine whether incremental demands are
  independent of price.
• 3. If 2 is satisfied, enter a contract for
  average requirement during some period at a
  particular price, say 2.00 MMBtu.

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Constant Trading Can Fix or Hedge Price

• 4. Then purchase gas when daily requirements are
  above average requirements.
• 5. And sell gas when daily requirements are below
  average requirements.
• 6. This simple strategy essentially fixes the
  cost of gas at 2.00 MMBtu.
• 7. It depends on whether a company has access to
  a market such as an electronic daily auction
  market.

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A Numerical Example of Constant Trading Strategy
Action
Needs

• Day 1 600 Buys 100 Mcf at 2.20 -200.00
• Day 2 550 Buys 50 Mcf at 2.30 -150.00
• Day 3 300 Sells 200 Mcf at 2.20 400.00

etc., if the customer has done the work right the
s and -s cancel out and the customer effectively
fixes the cost
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An Example for Figuring Out the Effective Cost of
Firm Capacity
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Transportation Costs and Cost of Unused Capacity
To obtain the cost of unused capacity

• Total Cost of Firm Transportation
• - Revenues from Capacity Release
• Net Cost of Transportation

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Transportation Costs and Cost of Unused Capacity

• Total Cost of Firm Transportation
• Amount Contracted

Net Transportation Cost Amount Used
-
CU
CU Cost of Unused Capacity per Unit Used
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Transportation Costs and Cost of Unused Capacity
An Example,
100,000 200,000 Mcf
90,000 100,000 Mcf
-
0.90 Mcf - 0.50 Mcf 0.40
Mcf
Thus the cost of unused capacity per unit is
0.40 Mcf
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The Volatility Bargain

• Short term volatility is likely to be sustained
  as long as the bargain that short-term volatility
  implies a better allocation of the commodity in
  the short-term, and a better allocation of
  capital in the mid-term.

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The Volatility Bargain

• Volatility bargain suggests a drop in capital
  cost per dollar of deliverability when moving
  from a highly regulated industry to a less
  regulated industry. This means continued
  increases in capacity turnbacks unless aggregate
  demand increases significantly.