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Constellation Blog - The Components of Natural Gas Price & Effective Purchasing Strategies
While the market has stayed low for some time, we still see occasional spikes of volatility. Because of this market volatility, new energy managers should understand the components of their total gas price and evaluate their natural gas purchasing strategy.
In the third part of our Gas 101 video series, we talk about two primary components of energy price: commodity price, which is based on the NYMEX Henry Hub futures price and basis (e.g., transportation and storage are two elements of basis).
What is Commodity Price?
A customer’s commodity price is based on the NYMEX, a national and recently-named international benchmark price of natural gas. The NYMEX is based on the price of gas at the Henry Hub in Erath, Louisiana, and serves as the official delivery location for futures contracts for NYMEX—known as the “NYMEX Henry Hub futures price.” A futures contract refers to the value today on the future delivery of gas, so for example, January 2022 gas has real, tradable value today in 2020.
All customers can base their physical natural gas price on the NYMEX. Many customers find that it is transparent because they can at any time access NYMEX prices online. The NYMEX can be referenced as the general value of natural gas at a point in time while the local cost of gas is more specific to the region’s supply and demand, weather and other factors; this is where basis price comes in.
What is Basis?
Basis is the price differential between the NYMEX (the general benchmark) and the local cost of gas (the specific location). It is often mistaken with transport, but transport is only one of multiple factors that can play into basis pricing. Basis includes your physical costs for transportation, fuel, storage and local production, and because it is calculated as a price differential, it is possible to have a negative price.
The commodity (or NYMEX) plus basis equals total physical natural gas costs. The ability to lock or float these price components independently helps to give customers options in how they choose to manage their costs.
Gas Purchasing Strategies
Many businesses and organizations have shifted their focus from more than just price. Strategic risk management of both NYMEX and basis costs helps support long-term budget certainty and minimize uncertainty. We commonly see customers employing three primary price instruments–Fixing, Floating, and Managing–to build their strategy, and it is common for customers to use more than one at a time.
Maximizing price certainty: Fixing a price
Fixed pricing is a mechanism to lock a single price per one million British Thermal Units (MMbtu) or dekatherm (dth) for volume and term at an exact delivery point. A customer can fix the NYMEX price, the basis price or both together. The upside to fixed pricing is price certainty; the only thing that is uncertain is how much their business is actually going to use. At the start of the contract, energy managers must estimate their business’ energy usage and will be charged for that estimate throughout the entirety of the contract. In addition to potentially purchasing more gas than needed, another downside to fixed pricing is when the market declines, customers may miss out on an opportunity to procure a lower rate.
Maximizing market opportunity: Floating a price
Floating is a mechanism that gives you the market price at the time of flow, taking advantage of market movements. “Generally speaking, historically, customers do better on a floating price, but they must be willing and able to take on risk if the market changes exponentially,” according to Jenny Herlache, director of regional sales at Constellation.
Balancing Flexibility and Certainty: Managing a portfolio
The best time to lock is when the market is rising. The best time to float is when the market is falling. This is the challenge: how do you know which direction the market will go? That’s why you take a managed approach: plan for both and use both price instruments–a combination of fixing and floating–to build a portfolio.
You can lock in some of your price to help shield against market spikes. Some will be left open to float with the market to capture any dips that might occur. “This falls in between budget certainty and risk tolerance; it’s a good balance,” says Herlache.” It’s like your 401K – you’re investing at certain intervals; you may not experience high highs or low lows. You’re purchasing the gas you need at different periods along your contract.”
Constellation’s SmartPortfolio program is a helpful tool that enables automated diversified purchasing. It offers multiple volatility protection levels, allows you to choose the right plan based on your preferences for budget certainty and manage your risk over time, using dollar-cost averaging.