If you don’t look at natural gas basis every day, you might not have noticed that the difference between the highest and the lowest natural gas cash prices in the U.S. fell below $1.00 on Tuesday. Based on ICE prices, the maximum price spread was $0.82/MMbtu on 2/15/12 and $0.83 yesterday. If you like trading basis[1], there is not much good to say about these numbers.
As you might expect, the highest prices were in the Northeast, with Tennessee Zone 6 getting the honors on Tuesday at +$.76 and Algonquin Citygates hitting the max number yesterday at +$.72. The low side was Texas Eastern E. Texas at $(.06) on Tuesday and Texas Eastern S. Texas at $(.11) on Wednesday. With the exception of a couple of aberrant days in December, this is a milestone of flat basis. Sadly for basis trading shops, sub-$1.00 spreads probably won’t be that unusual in the coming months.
Flat basis is no new news. Ever since 2009-10 when prices dropped down to the $4.00 range and a lot of new pipelines were completed, the big basis numbers traditionally seen in these markets evaporated. Now with the HH price evaporating too, the differentials are lower and narrower still and unlikely to recover any time soon.
What are some of the implications of this development? First, long haul transportation on pipelines is not such a good thing for shippers to hold. For example, at the supply end of REX (CIG Rockies) the price was $2.49 yesterday. At the market end, Columbia Gas TCO Pool was at $2.57. Variable transportation cost between the two points is somewhere in the neighborhood of 25 cents. So that spread is 17 cents underwater. It’s hard to make money moving gas when it costs more to move it than you get for making the move.
Second, this is obviously not a good thing for pipelines. Even on a variable basis, transportation costs on many pipelines are well above the differential between market hubs. About the only good news is that the fuel component of cost (which varies along with the price of gas) is down, so that brings the variable cost lower. Of course there is the big fixed component of transportation cost – the reservation fee – that we are not even talking about here. And one more thing, many of the pipes have long term contracts with shippers rolling off over the next few years. That will place some of these pipes in difficult circumstances.
To continue with the REX example, a few days ago S&P lowered the corporate credit and senior unsecured debt ratings on REX to 'BB' from 'BBB-, saying “Delaware-based pipeline operator Rockies Express Pipeline LLC (REX) is experiencing a combination of sustained compression in low natural gas basis differentials, which heightens recontracting risk primarily in 2019, and somewhat aggressive financial metrics. The ratings are based on REX's stand-alone credit quality separate from those of its sponsors (Kinder Morgan, Sempra and ConocoPhillips). The stable outlook reflects our expectation of stable cash flows and debt leverage metrics due to existing contracts.”
Finally, there are the trading opportunities, or lack thereof. Back in the good ole days (before 2009) a lot of natural gas trading shops made good money on the volatility of basis. The differential ranges were wide, and whipsawed the market when cold weather, new pipelines, increasing production or other events alternately crushed and spiked prices across the pipeline grid. Now those days are few and far between. Trading shops are scaling back gas basis desks, or getting out of that business altogether. Of course, physical gas will always need to be moved and there will always be the need for cash and financial trading of basis. But the days of big money spec basis shops are behind us for a while.
One bright spot in all of this is that the locations of associated gas from crude oil plays and from liquids rich plays are not in the same place as many of the new pipelines built over the past few years. Dry gas production is clearly declining, while rich and associated gas areas continue to increase. Could there be enough of a shift in the location of production growth to create transportation constraints that would generate a renewal of basis trading opportunities? Possibly, but only to a limited extent. NO! DON'T DESTROY IT, IT WORKS!"
A better bet is to follow the producers into NGLs and crude oil. That’s where you’ll see lots of basis volatility over the next few years.
[1] As used here, the term “basis” means location basis, or the difference between the U.S. natural gas reference price at Henry Hub and other regional hub prices.
