Henry The Hub, I Am I Am – What Really Drives Liquidity at the U.S. Natural Gas Benchmark

The Henry Hub, LA physical interconnect at the center of North American natural gas pricing is about to go through big changes with the in-service of liquefied natural gas (LNG) export terminals as soon as the end of 2015 and growing industrial demand in the Gulf Coast region. These changes are also likely to impact the CME/NYMEX futures contract that is based on delivery at Henry.  To understand how the demand growth nearby will impact Henry Hub cash and futures markets, we must first understand what really goes on physically at Henry. In today’s blog, we dive into the workings of the physical Henry spot market.

Recap

This is the third blog in our Henry Hub series. We started the series in Part 1 with the origins of Henry Hub, how it was the solution for a dying asset – the Sabine Pipeline -- hatched by two Texaco execs who came up with a plan not only to revive liquidity on the pipeline but to pitch it as a hub to the NYMEX in a bid to win the competition for the natural gas futures contract delivery point. We covered some of the distinctive features of the hub, including that it is not a hub in the strictest sense but that it is well connected and liquid in spite of that. In Part 2, we addressed the criteria that are essential to developing a healthy futures contract and how Henry fits that bill. In particular there must be an underlying physical market that has reliable mechanisms for physical delivery, which in turn allows the market to be highly fungible and liquid.  The physical market provides a realistic mechanism for pricing the futures contracts and prevents the futures market from going wildly off-track from spot market values.

Henry has made for an extremely successful futures contract for going on 25 years now. The CME/NYMEX Henry Hub gas futures contract traded average volumes equivalent to roughly 3,250 Bcf/d during the first seven months of 2015 (that’s for all delivery contracts – it works out to about 43 times the daily U.S. dry gas production of 75 Bcf/d). Based on that, you would think that Henry Hub would be the busiest physical gas interchange in the world, with high volumes moving through it. But not so.  In fact, given the importance of Henry to the gas market, it may be downright shocking how little actually flows through it.  That fact has prompted some to question its qualification as the basis for a futures contract and as a proxy for the rest of the U.S. gas market. In particular, the skeptics cite the shift in supply growth to the Marcellus in the Northeast. Certainly liquidity has increased at Northeast supply hubs, and that may someday warrant a futures contract in that region. However, there is no evidence that Henry is somehow negatively affected by relatively low levels of physical flows, and the likelihood of a Northeast hub supplanting Henry anytime soon is pretty remote. Today we begin our explanation of why this is the case with a detailed look at how the Hub is laid out, geographically and conceptually.

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Sabine Pipeline and Henry Hub Layout

As we pointed out in Part 1, Henry is not a hub in the traditional “classic” sense with multiple pipelines fanning out from a single location, like spokes on a wagon wheel. Rather it is a conceptual hub with the critical features of a well-connected, efficient and liquid hub, comprising 13 interstate and intrastate pipeline connections scattered around Vermillion Parish, LA, near a little town called Erath. The Sabine Pipeline, owned and operated by Enlink Midstream following an acquisition from Chevron in 2014, is the backbone of Henry Hub. The map in Figure 1 shows Sabine (blue line), which stretches from East Texas to a former processing plant at Henry, LA – just south of Erath. 

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