Natural gas marketing is a relatively new addition to
the natural gas industry, beginning in the mid-1980's. Prior to the deregulation of
the natural gas commodity market and the introduction
of open access for everyone to natural gas pipelines,
there was no role for natural gas marketers. Producers
sold to pipelines, who sold to local distribution companies
and other large volume natural gas users. Local distribution
companies sold the natural gas purchased from the pipelines
to retail end users, including commercial and residential
customers. Price regulation at all levels of this supply
chain left no place for others to buy and sell natural
gas. However, with the newly accessible competitive markets
introduced gradually over the past fifteen years, natural
gas marketing has become an integral component of the
natural gas industry. In fact, the first marketers were
a direct result of interstate pipelines attempting to
recoup losses associated with long term contracts entered
into as a result of the oversupply problems of the early
1980s. To learn more about the history of natural gas
regulation, click here.
Natural gas marketing may be defined as the selling
of natural gas. In even looser terms, marketing can
be referred to as the process of coordinating, at various
levels, the business of bringing natural gas from the
wellhead to end-users. The role of natural gas marketers
is quite complex, and does not fit exactly into any
one spot in the natural gas supply chain. Marketers
may be affiliates of producers, pipelines, and local
utilities, or may be separate business entities unaffiliated
with any other players in the natural gas industry.
Marketers, in whatever form, find buyers for natural
gas, ensure secure supplies of natural gas in the market,
and provide a pathway for natural gas to reach the end-user.
It is natural gas marketers that ensure a liquid, transparent
market exists for natural gas. Marketing natural gas
can include all of the intermediate steps that a particular
purchase requires; including arranging transportation,
storage, accounting, and basically any other step required
to facilitate the sale of natural gas.
Essentially, marketers are primarily concerned with
selling natural gas, either to resellers (other marketers
and distribution companies), or end users. On average,
most natural gas can have three to four separate owners
before it actually reaches the end-user. In addition
to the buying and selling of natural gas, marketers
use their expertise in financial instruments and markets
to both reduce their exposure to risks inherent to commodities,
and earn money through speculating as to future market
To view statistics related to the selling and marketing
of natural gas, including prices and volumes, click
In order to more fully understand the role and function
of natural gas marketers, it is helpful to have an understanding
of the basics of natural gas markets.
Natural Gas as a Commodity
Natural gas is sold as a commodity, much like pork
bellies, corn, copper, and oil. The basic characteristic
of a commodity is that it is essentially the same product
no matter where it is located. Natural gas, after processing,
fits this description. Commodity markets are inherently
volatile, meaning the price of commodities can change
often, and at times drastically. Natural gas is no exception;
in fact, it is one of the most volatile commodities
currently on the market. The graph below shows the
|Natural Gas Volatility and Price
Levels at Henry Hub
|Source: Energy Information
Administration, Office of Oil and Gas; based on
Natural Gas Monthly publications
The price of natural gas is set by market forces; the
buying and selling of the commodity by market players,
based on supply and demand, determines the average price
of natural gas. There are two distinct markets for natural
gas: the spot market, and the futures market. Essentially,
the spot market is the daily market, where natural gas
is bought and sold 'right now'. To get the price of
natural gas on a specific day, it is the spot market
price that is most informative. The futures market consists
of buying and selling natural gas under contract at
least one month, and up to 36 months, in advance. For
example, under a simplified futures contract, one could
enter into an agreement today, for delivery of the physical
gas in two months. Natural gas futures are traded on
York Mercantile Exchange (NYMEX). Futures contracts
are but one of an increasing number of derivatives contracts
used in commodities markets, and can be quite complex
and difficult to understand. To learn more about futures
and other methods of buying, selling, and trading commodities,
|Major Natural Gas Market Hubs
|Source: Energy Information
Natural gas is priced and traded at different locations
throughout the country. These locations, referred to
as 'market hubs', exist across the country and are located
at the intersection of major pipeline systems. There
are over 30 major market hubs in the U.S., the principle
of which is known as the Henry Hub, located in Louisiana.
The futures contracts that are traded on the NYMEX are
Henry Hub contracts, meaning they reflect the price
of natural gas for physical delivery at this hub. The
price at which natural gas trades differs across the
major hubs, depending on the supply and demand for natural
gas at that particular point. The difference between
the Henry Hub price and another hub is called the location
differential. In addition to market hubs, other major
pricing locations include 'citygates'. Citygates are
the locations at which distribution companies receive
gas from a pipeline. Citygates at major metropolitan
centers can offer another point at which natural gas
Physical and Financial Trading
There are two primary types of natural gas marketing
and trading: physical trading and financial trading.
Physical natural gas marketing is the more basic type,
which involves buying and selling the physical commodity.
Financial trading, on the other hand, involves derivatives
and sophisticated financial instruments in which the
buyer and seller never take physical delivery of the
Like all commodity markets, the inherent volatility
of the price of natural gas requires the use of financial
derivatives to hedge against the risk of price movement.
Buyers and sellers of natural gas hedge using derivatives
to reduce price risk. Speculators, on the other hand,
assume greater risk in order to profit off of changes
in the price of natural gas. Some marketers who actively
buy and sell in either the physical or financial markets
are referred to as natural gas 'traders'; trading natural
gas on the spot market to earn as high a return as possible,
and trading financial derivatives and other complex
contracts to either hedge risk associated with this
physical trading, or speculate about market movements.
Most marketing companies have elaborate trading floors,
including televisions and pricing boards providing the
traders with as much market information as possible.
|Trading Floor at a Natural Gas
Physical trading contracts are negotiated between buyers
and sellers. There exist numerous types of physical
trading contracts, but most share some standard specifications
including specifying the buyer and seller, the price,
the amount of natural gas to be sold (usually expressed
in a volume per day), the receipt and delivery point,
the tenure of the contract (usually expressed in number
of days, beginning on a specified day), and other terms
and conditions. The special terms and conditions usually
outline such things as the payment dates, quality specifications
for the natural gas to be sold, and any other specifications
agreed to by both parties.
Physical contracts are usually negotiated between buyers
and sellers over the phone. However, electronic bulletin
boards and e-commerce trading sites are allowing more
physical transactions to take place over the internet.
There are three main types of physical trading contracts:
swing contracts, baseload contracts, and firm contracts.
Swing (or 'interruptible') contracts are usually short-term
contracts, and can be as short as one day and are usually
not longer than a month. Under this type of contract,
both the buyer and seller agree that neither party is
obligated to deliver or receive the exact volume specified.
These contracts are the most flexible, and are usually
put in place when either the supply of gas from the
seller, or the demand for gas from the buyer, are unreliable.
Baseload contracts are similar to swing contracts.
Neither the buyer nor seller is obligated to deliver
or receive the exact volume specified. However, it is
agreed that both parties will attempt to deliver or
receive the specified volume, on a 'best-efforts' basis.
In addition, both parties generally agree not to end
the agreement due to market price movements. Both of
these understandings are not legal obligations - there
is no legal recourse for either party if they believe
the other party did not make its best effort to fulfill
the agreement - they rely instead on the relationship
(both personal and professional) between the buyer and
Firm contracts are different from swing and baseload
contracts in that there is legal recourse available
to either party, should the other party fail to meet
its obligations under the agreement. This means that
both parties are legally obligated to either receive
or deliver the amount of gas specified in the contract.
These contracts are used primarily when both the supply
and demand for the specified amount of natural gas are
unlikely to change or drop off.
The daily spot market for natural gas is active, and
trading can occur 24 hours a day, seven days a week.
However, in the natural gas market, the largest volume
of trading occurs in the last week of every month. Known
as 'bid week', this is when producers are trying to
sell their core production and consumers are trying
to buy for their core natural gas needs for the upcoming
month. The core natural gas supply or demand is not
expected to change; producers know they will have that
much natural gas over the next month, and consumers
know that they will require that much natural gas over
the next month. The average prices set during bid week
are commonly the prices used in physical contracts.
The Financial Market
In addition to trading physical natural gas, there
is a significant market for natural gas derivatives
and financial instruments in the United States. In fact,
it has been estimated that the value of trading that
occurs on the financial market is 10 to 12 times greater
than the value of physical natural gas trading.
Derivatives are financial instruments that 'derive'
their value from an underlying fundamental; in this
case the price of natural gas. Derivatives can range
from being quite simple, to being exceedingly complex.
Traditionally, most derivatives are traded on the over-the-counter
(OTC) market, which is essentially a group of market
players interested in exchanging certain derivatives
among themselves, as opposed to through a market like
the NYMEX. Basic types of derivatives include futures,
options, and financial swaps. To learn more about the
basics of derivatives, click here.
There are two possible objectives to trading in financial
natural gas markets: hedging and speculation. Trading
in the physical market involves a certain degree of
risk. Price volatility in the natural gas markets can
result in financial exposure for marketers and other
market players as the price changes over time. Trading
financial derivatives can help to mitigate, or 'hedge'
this risk. A hedging strategy is created to reduce the
risk of losing money. Purchasing homeowner's insurance
is a common hedging activity. Similarly, a marketer
who plans on selling natural gas in the spot market
for the next month may be worried about falling prices,
and can use a variety of financial instruments to hedge
against the possibility of natural gas being worth less
in the future. Countless strategies exist to hedge against
price risk in the natural gas market, including natural
gas futures, derivatives based on weather conditions
to mitigate the risk of weather affecting the supply
of natural gas (and thus its market price), etc. To
learn more about the basics of hedging in the natural
gas market visit the New York Mercantile Exchange here.
Financial natural gas markets may also be used by market
participants who wish to speculate about price movements
or related events that may come about in the future.
The main difference between speculation and hedging
is that the objective of hedging is to reduce risk,
whereas the objective of speculation is to take on risk
in the hope of earning a financial return. Speculators
hope to forecast future events or price movements correctly,
and profit through these forecasts using financial derivatives.
Trading in the financial markets for speculative purpose
is essentially making an investment in financial markets
tied to natural gas, and financial speculators need
not have any vested interest in the buying or selling
of natural gas itself, only in the inherent underlying
value that is represented in financial derivatives.
While great profits may be made if the expectations
of a speculator prove correct, great losses may also
be incurred if these expectations are wrong. While the
instruments used for hedging and speculation are the
same, the way in which they are used determines whether
or not they in fact reduce, or increase, the risk of
Now that some of the basics of the natural gas market
have been covered, we can examine the function of natural
|Marketers in Action
Natural Gas Marketers
Any party who engages in the sale of natural gas can
be termed a marketer, however they are usually specialized
business entities dedicated solely to transacting in
the physical and financial energy markets. It is commonplace
for natural gas marketers to be active in a number of
energy markets, taking advantage of their knowledge
of these markets to diversify their business. Many natural
gas marketers are also involved in the marketing of
electricity, and in certain instances crude oil.
Marketers can be producers of natural gas, pipeline
marketing affiliates, distribution utility marketing
affiliates, independent marketers, and large volume
users of natural gas. A recent study of the origins
of natural gas marketers found that 27 percent of the
top 30 natural gas marketers in 2000 were entities spun
off from interstate pipeline companies. An equal percentage
was made up of entities affiliated with local distribution
companies. About 30 percent of the top natural gas marketers
were originally affiliated with producers, and entities
formed from large volume natural gas consumers comprise
6 percent. Finally, independent, newly formed entities
represent 10 percent of top natural gas marketers.
Marketing companies, whether affiliated with another
member of the natural gas industry or not, can vary
in size and the scope of their operations. Some marketing
companies may offer a full range of services, marketing
numerous forms of energy and financial products, while
others may be more limited in their scope. For instance,
most marketing firms affiliated with producers do not
sell natural gas from third parties; they are more concerned
with selling their own production, and hedging to protect
their profit margin from these sales.
There are basically five different classifications
of marketing companies: major nationally integrated
marketers, producer marketers, small geographically
focused marketers, aggregators, and brokers.
The major nationally integrated marketers are the 'big
players', offering a full range of services, and marketing
numerous different products. They operate on a nationwide
basis, and have large amounts of capital to support
their trading and marketing operations. Producer marketers
are those entities generally concerned with selling
their own natural gas production, or the production
of their affiliated natural gas production company.
Smaller marketers target particular geographic areas,
and specific natural gas markets. Many marketing entities
affiliated with LDCs are of this type, focusing on marketing
gas for the geographic area in which their affiliated
distributor operates. Aggregators generally gather small
volumes from various sources, combine them, and sell
the larger volumes for more favorable prices and terms
than would be possible selling the smaller volumes separately.
Brokers are a unique class of marketers in that they
never actually take ownership of any natural gas themselves.
They simply act as facilitators, bringing buyers and
sellers of natural gas together.
All marketing companies must have, in addition to the
core trading group, significant 'backroom' operations.
These support staff are responsible for coordinating
everything related to the sale and purchase of physical
and financial natural gas; including arranging transportation
and storage, posting completed transactions, billing,
accounting, and any other activity that is required
to complete the purchases and sales arranged by the
traders. Since marketers generally work with very slim
profit margins, the efficiency and effectiveness of
these backroom operations can make a large impact on
the profitability of the entire marketing operation.
In addition to the traders and backroom staff, marketing
companies typically have extensive risk management operations.
The risk management team is responsible for ensuring
that the traders do not expose the marketing company
to excessive risk. Top-level management is responsible
for setting guidelines and risk limitations for the
marketing operations, and it is up to the risk management
team to ensure that traders comply with these directives.
Risk management operations are quite complex, and rely
on complex statistical, mathematical, and financial
theory to ensure that risk exposure is kept under control.
Most large losses associated with marketing operations
occur when risk management policies are ignored or are
not enforced within the company itself.
The marketing of natural gas is an integral part of
the natural gas supply chain. Natural gas marketers
ensure that a viable market for natural gas exists at
all times. Efficient and effective physical and financial
markets are the only way to ensure that a fair and equitable
commodity price, reflective of the supply and demand
for that commodity, is maintained.
To learn more about what factors affect the supply
and demand for natural gas, and an overview of natural
gas markets in the United States, click here.