2141 Physical and Financial Markets

Since natural gas is a commodity—it is fungible— and its supply is at times at the mercy of many factors including weather, demand, economics, etc., there is a market for buying gas supplies in the future. Commonly, this is called the "futures market" as opposed to the physical market where the actual commodity goes to the buyer either for resale or consumption. Many users of natural gas buy or "hedge" on the commodity market to take advantage of prices offered in the future. The New York Commodity Exchange (NYMEX) offers contracts for up to 36 months and several banks and operators do an over the counter market offering prices even further out. The consumers or sellers (producers, marketers, users, etc.) using the futures market are usually hedging as a means of price risk protection.

As an example, a fertilizer manufacturer is a large user of natural gas for making ammonia and derivatives for use in fertilizers and industrial chemicals. If it takes the ammonia manufacturer an average of 60 to 90 days from the time he buys the raw material natural gas to be ready to sell it as ammonia, he has to worry about the price of both the ammonia and the price of the replacement natural gas changing during the period. If he uses $2 per MMBtu gas for the ammonia and then after selling the ammonia has to buy $3 per MMBtu gas to make new ammonia, he could be at a price disadvantage in the ammonia market. To "hedge" against these kinds of price changes, the manufacturer can buy "futures" when he starts making ammonia with the $2 raw material. He can protect his future-buying price for the raw material, which represent 70-80 percent of the manufactured cost of the ammonia, by hedging his future purchases.

Since the prices on the futures market move constantly, almost daily for the near term market and less as time goes out, the futures market makes an ideal medium of wagering what the price will be in the future. The "speculators" who come into the market have no need for the commodity nor will they most likely ever take actual physical ownership of it. Their purpose is strictly to wager on where the price will be on a certain date. It can be either up or down from the price on the day they buy "futures." This is not a small market but one in billions of dollars. In 1999, it was estimated that for every billion cubic feet of gas consumed in an average day, 10 to 12 billion cubic feet were traded on the NYMEX exchange and other markets. Of course, some of this 12-fold excess of consumption went to hedging, but roughly speculators traded 90 percent. The average amount of gas consumed per day in 1999 without regard to seasonality was about 60 billion cubic feet. Using the wellhead price of around $3.00/MMBtu, about $180 million was traded each average day for the consumption of gas. In the financial trading markets, almost two billion dollars per day were traded!

Other than to have mentioned the financial market and show its significance in the natural gas industry, this chapter is devoted to physical gas buying. The buyers and sellers both need to know about the financial markets and evaluate their own need to participate or not in this type of gas transactions. There are many marketing companies, financial houses, and consultants well versed in the financial markets and how trading in these can lower the over all purchase costs of the commodity. Many books are written on this aspect. Buyers and sellers should become familiar with all sources of information in this area in helping to either maximize the return for the product for the sellers or minimize the purchase costs for the consumers. The comments on buying gas for use does not negate the financial market but, leaves it to other sources for the users to learn how to work within the financial framework including its benefits and risks. Knowledge of the financial markets are necessary because of the impact the financial market has on the physical market and prices for natural gas.

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