If you are fortunate enough to have a natural-gas pipeline in close proximity to your building or plant, there’s good news: Pipelines are expanding, distribution is becoming more efficient than ever, and availability is increasingly widespread.
That’s because the way natural gas physically moves around the country is changing. Some pipelines are in the process of reversing flow direction as new sources come online. This leads to, at times, gas selling below the New York Mercantile Exchange (NYMEX) price.
Better Supply to Big Cities
In addition to the supply of natural gas available, production location has emerged as a prominent factor in prices. Because they are located near the Marcellus and Utica shale plays, two highly dense population areas have seen the most benefit.
In the Northeast, the staggering number of oil-to-gas conversions seen in New York and New England are not an aberration. Until recently, the delivered price of natural gas into the Northeast has included high scarcity premiums (charges made when downstream demand in excess of what current infrastructure can deliver). This has resulted in some of the highest basis costs in the country. Existing pipelines that flow northward from the Gulf traditionally have not been able to keep up with potential demand in the region.
However, new shale production in Pennsylvania and Ohio has begun to relieve demand for Gulf gas. Over the next two to three years, new pipelines and infrastructure will be brought online, further limiting scarcity premiums in the Northeast.
In the Midwest, the Rockies Express (REX) pipeline originates in Colorado and Wyoming, moves east, and ends near Wheeling, W.Va. The pipeline is divided into three sections, very similar to the division of Mountain, Central, and Eastern time zones.
REX will likely reverse its flow of gas from Zone 3, moving Marcellus and Utica gas west toward Missouri, while Zones 1 and 2 will continue to bring Rocky Mountain gas east into Missouri. This action likely will weaken gas prices in Chicago, St. Louis, Kansas City, and the Twin Cities. It could take several years for the change to affect the market, as REX has requested approval from the Federal Energy Regulatory Commission. Approval is likely in six months, with another six months needed to implement the change.
The Price Discrepancy
Although buyers are not complaining about current prices, some are scratching their heads. How can delivered gas be priced at NYMEX plus a few cents or (at times) even below NYMEX? To understand this, we need to look at the price components of natural gas before it reaches a customer’s utility distribution system.
NYMEX is simply the cost of the physical commodity traded on the exchange. The price is for gas delivered to the Henry Hub, which is a distribution point in Erath, La.
The basis price is the transportation cost to move the gas from the well to various utility distribution systems. Basis includes pipeline costs, taxes, supplier fees, and scarcity premiums. Basis prices will vary depending on the utility to which the gas is delivered.
So why, when purchasing gas, do some buyers see delivered prices below NYMEX? Why isn’t the NYMEX price simply lower? The reason is that although current gas prices are set in Louisiana, there’s a strong argument to be made that prices should now be set in the Midwest, where most of the new gas activity is having a big impact.
Scarcity premiums in basis prices vary by location, and currently some locations have a negative basis price. The discount is what producers charge for their gas vs. the NYMEX traded price. Centrally located production in Pennsylvania and Ohio has exacerbated the market’s supply-demand imbalance.
Regardless of where the “discount” is coming from, it’s a win for the end user. One thing is certain: America is developing the infrastructure needed to better utilize its natural-gas resources.