Energy Information Administration Markets, Hubs, Trading Places, and Capacity Release Markets by John H. Herbert

Energy Information Administration 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.

Energy Information Administration A Lot of Interesting Market Developments

Energy Information Administration West Texas Market Centers Interplay With North and East Texas and Loiusiana Market Centers

Energy Information Administration Streamline Auction Market Volume Traded

Energy Information Administration Energy Exchange Auction Market - Intra-Alberta (Number of Trades)

Energy Information Administration Price Risk and Market Centers and Hubs l How Much Price Risk or Volatility is There? l A Lot!

Energy Information Administration Volatilities - NYMEX Natural Gas Futures Market, November 1996 To May 1997 Most commodities average volatilities below 20

Energy Information Administration Why Is There So Much Short Term Price Risk? l New Inventory Management Strategies l Fuller Use of Existing Pipeline Capacity Weather events - there is no commodity in which the demand varies more in the short term Other Reasons:

Energy Information Administration Responses To Short Term Price Volatility l Flexibility in Contracting and in Services - Market Hubs and Centers

Energy Information Administration Encouraging Trade l 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

Energy Information Administration Encouraging Exchanges l 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.

Energy Information Administration Encouraging Exchanges l 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.

Energy Information Administration Constant Trading - Firm Capacity l Constant Trading Works Well as Long as a Company Has Firm Capacity

Energy Information Administration l Constant Trading can Work even Better if Company Trades Pipe Capacity the Same Way it Trades the Commodity Constant Trading - Pipe Capacity

Energy Information Administration Constant Trading - Release Capacity l Constant Trading Works Best for a Company When the Price of Release Capacity is Independent of the Price of Commodity

Energy Information Administration 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.

Energy Information Administration 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.

Energy Information Administration A Numerical Example of Constant Trading Strategy Day 1600Buys 100 Mcf at $2.20 = -$ Day 2550Buys 50 Mcf at $2.30 = -$ Day 3300Sells 200 Mcf at $2.20 = +$ etc., if the customer has done the work right the +s and -s cancel out and the customer effectively fixes the cost Action Needs

Energy Information Administration An Example for Figuring Out the Effective Cost of Firm Capacity

Energy Information Administration To obtain the cost of unused capacity: Total Cost of Firm Transportation -Revenues from Capacity Release Net Cost of Transportation Transportation Costs and Cost of Unused Capacity

Energy Information Administration - Total Cost of Firm Transportation Amount Contracted Net Transportation Cost Amount Used CU =Cost of Unused Capacity per Unit Used CU = Transportation Costs and Cost of Unused Capacity

Energy Information Administration Transportation Costs and Cost of Unused Capacity An Example, $100, ,000 Mcf - $0.90 Mcf - $0.50 Mcf = $0.40 Mcf $90, ,000 Mcf Thus the cost of unused capacity per unit is $0.40 Mcf

Energy Information Administration 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.

Energy Information Administration 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.