Why are my Natural Gas Rates Different than the NYMEX?
Have you ever wondered why your natural gas rates at your home or business are much different than the natural gas rates displayed on financial news, like here on Bloomberg? Why are you paying $4.25 / dekatherm at your business when experts tout that gas prices are falling to $2.50 / dekatherm? We’re here to explain how the U.S. natural gas markets work and how to ensure you are getting the best deal. Here’s how it works…
Physical vs. Financial Natural Gas
To understand this price phenomena, we must first wrap our brains around physical natural gas and financial natural gas rates. Unlike a stock, natural gas has a physical component (it is used to heat homes and run machinery in the real world). The prices for natural gas displayed on outlets like Bloomberg and CNBC are financial in nature; however, each financial purchase of natural gas, requires that it be delivered to a physical location at some point in time. Many financial traders cannot take physical delivery of natural gas and usually sell their financial positions before they are required to do so.
The most important concept to understand here is that each physical delivery location has a different financial price. Winter heating demand in Chicago is much higher than that of South Carolina. In a normal world, prices for natural gas being delivered to Chicago during the winter should be much higher than those in South Carolina.
The Henry Hub
The Henry what? If you’re like most, you’ve never heard of the Henry Hub, but do not fret, we will make it simple. The Henry Hub is a physical natural gas delivery location in Louisiana where many major natural gas pipelines converge. In fact, if you take a look at the map below from the EIA, you will see this heavy concentration of pipelines.
The Henry Hub represents a location where a high volume of natural gas is physically delivered on a daily basis. The New York Mercantile Exchange (NYMEX), the world’s largest commodities exchange, sets the prices for natural gas that you see on various news outlets. These prices are based on the price to deliver or buy gas at the Henry Hub, the nation’s most liquid natural gas trading hub. If you were located next to the Henry Hub, your cost for gas would be very close to the NYMEX price; however, this is usually not the case.
Why is my Price Different?
The difference in your price and the NYMEX price displayed on CNBC comes down to two things: location and cost to transport. Just as the Henry Hub is a liquid delivery location in Louisiana, there are many delivery locations and hubs throughout the U.S. See the map below of the top 25 natural gas trading hubs and zones throughout the country.
Because supply and demand (the main drivers of price change) are different at each natural gas trading location, price will vary from location-to-location. So if the prompt month’s NYMEX natural gas contract is trading at $2.50, that is the cost of natural gas to be delivered at the Henry Hub. This price will vary from the delivery price at the Chicago Citygate.
What About Transport?
Great question! One of the key factors in the price differential between the Henry Hub and other trading locations is the cost to transport the gas over the pipeline. Gas pipeline operators are regulated by tariffs at the local and federal levels, and the cost to transport is typically comprised of three major components.
- Capacity Charge – a flat, fixed charge to send gas across a pipeline.
- Fuel Charge – a cost per unit of natural gas transported.
- Admin Charge – an administrative charge to cover the pipeline’s admin costs.
Because transport fees are regulated by the government, energy companies are able to forecast their costs to deliver gas to your location. This transport cost makes up what the market calls ‘basis’ which is the difference between your trading location and the Henry Hub.
What Does It Mean For You?
We are assuming that you are not looking to start a career trading natural gas. If you are, there are much more detailed and reliable resources than this. However, understanding how your natural gas rate is calculated is critical to ensuring you are getting the best price for your natural gas supply. Here are some great questions to ask your natural gas broker or supplier the next time you buy.
- What is the cost of the NYMEX contracts that correspond with my delivery times?
- How do those NYMEX prices compare to historical averages?
- What is the transport cost and what tariff is being used to calculate it?
- What is the historical price of my delivery location?