The term “natural gas prices” is often used to refer to a number of different types of prices. Some natural gas prices refer to the point in the market where the natural gas is purchased, other prices are based on the timing of delivery and some prices refer to pricing mechanisms. These different prices include – but are not limited to – wellhead prices, spot prices, futures (NYMEX) prices, citygate prices and residential prices. It’s important to be specific about the type of price under discussion and to understand the relationship among the various types.
PRICES THAT REFER TO THE POINT OF SALE ARE:
The wellhead price is the wholesale price of natural gas at its point of production. It is not regulated and the most important factor affecting natural gas wellhead prices is the competitive marketplace. Factors that affect wellhead gas prices include the available supply of natural gas, weather, overall gas demand, the prices of competing fuels (primarily coal and oil) and competition between gas companies for the supplies.
The "city gate" is generally the point where natural gas is transferred from an interstate or intrastate pipeline to a local natural gas utility. The "city gate price" is the sales price of the natural gas at this point: the price reflects the wholesale/wellhead price as well as the cost of transporting the natural gas by pipeline to the citygate. Citygate prices can show tremendous variation between regions, often reflecting regional usage patterns, weather trends and the number of competing interstate pipelines serving each region.
The residential price is the price that customers pay for heating their homes. Residential prices include the cost of the natural gas itself, as well as a separate charge for service and delivery. The home-heating bill also often includes state and local taxes that governments add to the bill. On average, the price of the natural gas commodity comprises about two-thirds of the total home energy bill. By law, utilities may not mark-up the price of the natural gas commodity.
PRICES THAT REFER TO THE TIMING OF DELIVERY OF THE NATURAL GAS ARE:
Short-Term Contract Natural Gas Prices
Most of the natural gas that utilities use during the winter heating season is contracted for under “short-term contracts” – contracts that are negotiated anywhere from one month to one year prior to physical delivery of the natural gas. An example of a typical transaction might involve a local natural gas utility agreeing to the short-term contract price and other conditions in June, with an arrangement for actual delivery by pipeline scheduled for December. Utilities enter into numerous short-term contracts with different pipeline suppliers for different delivery dates in order to ensure a reliable supply of natural gas at competitive rates for their customers.
Spot Market Prices
Another type of arrangement in the natural gas market exists as the “spot market.” The spot market is a source of natural gas that is needed within a matter of days rather than months. The spot market allows local natural gas utilities to respond quickly to changing weather or other market conditions. The spot market is especially sensitive to changing market conditions and spot market prices quickly respond to changes in weather or availability of supply.
Long-Term Contract Natural Gas Prices
A small amount of natural gas that utilities use during the winter heating season is contracted for under “long-term contracts” – contracts that are negotiated one year or more in advance of physical delivery of the natural gas.
Because utilities' gas supply portfolios are diversified among spot purchases, long-term contract gas, storage gas and other sources, price spikes in one arena do not have an immediate impact on residential customers.
Local natural gas utilities often purchase natural gas during the “shoulder months” of the year, when it is traditionally at lower prices, and store the gas for later use during the winter. On average, a little less than 20 percent of the natural gas that is used by residential customers over the entire winter heating season comes from storage. However, on the peak days of the year – usually the coldest days – storage gas accounts for a much larger percentage of the natural gas flowing to customers.
Utilities may pay a pre-negotiated flat price for the natural gas they purchase under short- or long-term contract – or they may agree to a price that shifts to reflect changes in the spot, futures or even competing markets, such as heating oil. Contracts with price indexing are similar to an adjustable rate mortgage that changes as interest rates change.
The New York Mercantile Exchange (NYMEX) allows the sale of natural gas contracts for future delivery made under NYMEX rules. A natural gas futures contract typically is a financial tool used by buyers and sellers of natural gas to minimize risk. Very few natural gas transactions on the futures market involve any actual physical exchange of natural gas. Instead most natural gas futures contracts are liquidated by offsetting an obligation to sell natural gas with an obligation to buy natural gas. The delivery site for futures contracts is the Henry Hub, an interconnection of seven interstate and three intrastate pipelines in Erath, Louisiana. Most natural gas utilities do not participate in the futures market, but it is a robust market for natural gas marketers and promotes much-needed liquidity in the market.
Purchased Gas Adjustment
The natural gas price customers see on their bills – usually expressed in units as “therms” or in CCFs (hundreds of cubic feet) – is the same price the utility paid to purchase the natural gas. Like FedEx, utilities earn their income from delivery services, which appear as a separate line-item on the customer’s bill. Because the price to purchase the therms or cubic feet of natural gas changes frequently, state regulators have instituted a “purchased gas adjustment” process to allow natural gas utilities to pass along those price changes periodically. Some states require monthly purchased gas adjustment or “cost of gas adjustment” filings. Others are quarterly or based on a six-month average. The more frequent the adjustment, the sooner residential prices will reflect the actual upward or downward movements of the price paid by the utility for the gas it delivers.