Living in Fast Forward Curves – Making Sense of Forward Natural Gas Markets

Six months ago, the natural gas forward price for 2021 averaged $5.15/MMBtu.  Back then a producer could hedge forward production at that price.  Today 2021 is only $4.63/MMBtu, a decline of $0.52/MMBtu even though we are now in the middle of the winter.   Today the forward market doesn’t get above $5.00/MMBtu until 2026, certainly a disappointment for many a producer that didn’t hedge last summer. What does the market know about the future that is different from what was known back in June?  How do these forward curves work in the first place?  In this new blog series on North American natural gas forward curves we will provide background on the mechanics of forward curves, examine the forward curve in each of the major regions in the North American natural gas market, and do a deep dive into natural gas historical trends, major drivers and market expectations as related to forward markets.  

Before we jump into what makes forward curves fast, we first need to rewind real slow and consider what makes forward curves do what they do.

What is a Forward Curve?

Natural gas is traded every day at well over 100 market hubs across North America. These trading hubs are usually receipt or delivery points on pipelines or locations where two or more pipelines intersect. Natural gas is traded at these hubs for different delivery periods, ranging from same-day and next-day to well into the future. The most commonly traded, or liquid, delivery period for physical delivery of the gas is the next day, also known as the “spot” or “cash” market. Gas traded in the spot market today physically flows the next day. During the last five business days of each month, or so-called “bid-week,” buyers can also lock in supply for the following month by purchasing “baseload” gas for daily physical delivery for each day of that month, also called “prompt” month. Baseload is the minimum volume of gas needed for each day of the month based on anticipated demand. This allows buyers and sellers to lock in a price for physical delivery for the month, effectively minimizing the risk and uncertainty associated with the daily spot market. Any volume above or below baseload expectations ends up being traded in the next-day market or in storage. 

Trading for these physical markets occurs on exchanges, such as the Intercontinental Exchange (ICE), or directly between counterparties. The trades are reported to independent price reporting companies, such as Platts, NGI or Argus. These price-reporting firms then publish an index or settlement price for each pricing hub, typically the volume-weighted average of all the trades reported for each hub within the specified trading period. Platts Gas Daily Average (GDA), serves as the benchmark for next-day at the majority of pricing hubs, while Platts Inside FERC’s Monthly Index (IFERC) is the primary industry benchmark for most bid-week settlements, again with the exception of several hubs.

Trading for the prompt month or more than one month out into the future also occurs for each hub in the “forwards” or “futures” market.  In the North American natural gas market, the term “futures” is usually reserved for the CME/NYMEX contract at the Henry Hub in Louisiana, which is the national benchmark location for the North American gas market, while the term “forwards” usually refers to futures trading in the other price locations. (Technically any price for a delivery date in the future is a forward.)  Both the futures and forwards markets trade daily and reflect the value of gas in today’s trading activity for deliveries at a future time at a specific location. These transactions are usually financial in nature – involving a promise to pay or receive a fixed price for gas delivered during a specific month into the future at the given location. Forwards contracts are for delivery each day of a specified period of time in the future. Common contract periods for forwards include: a month, a season, a quarter or year. It is possible for forwards to be packaged for irregular or customized intervals by mutual agreement of trading counterparties, though this occurs less frequently than in years past due to regulatory issues we will discuss later in this blog series. When more than one sequential month is strung together and bought or sold as one contract, it is called a “strip.” The summer strip in the gas market is defined as April through October, while a winter strip is November through March.

Most forwards contracts settle at the end of each delivery month against the Platts/McGraw-Hill Inside FERC physical monthly index (IFERC). If the published IFERC index price is lower than the forwards contract value, the buyer pays the seller the difference. If the IFERC index posts at a higher price than the forward contract value, the seller pays the buyer the difference. Because forwards contracts settle against a floating monthly published index price, they are also referred to as “basis swaps,” meaning they are swapping one price for another at the time of contract settlement.

Price reporting firms, brokers and exchanges such as ICE  or the CME/NYMEX provide daily forwards settlement values for most price locations based on daily trading activity, reported trades or outstanding forward commitments for each month in the future as far out as trading liquidity allows. Liquidity generally diminishes the farther out into the future you go. The settlement prices for all monthly forward delivery contracts strung together consecutively for a particular price location form the forward curve for that location.