Natural gas markets significantly affect the economy and the individuals who rely on the fuel for electric generation, manufacturing, heating, cooking, and other purposes.
There is a physical market in which natural gas is produced, transported, stored, and consumed. There is also a financial market in which physical natural gas is bought and sold as a financial product derived from physical natural gas.
THE NATURAL GAS INDUSTRY HAS THREE MAJOR SEGMENTS
| UPSTREAM SEGMENT | MIDSTREAM SEGMENT | DOWNSTREAM SEGMENT |
| The upstream segment includes exploration and development of natural gas resources and reserves, production, which includes drilling and extraction at the wellhead, and gathering. | The midstream segment includes transportation on intrastate and interstate pipeline systems that move natural gas through large-diameter pipelines to storage facilities and a variety of consumers. | The downstream segment includes large gas consumers, such as power plants and industrial facilities, and local distribution companies, which deliver the natural gas to retail consumers. |
A.) PHYSICAL TRADING OF NATURAL GAS
Physical natural gas contracts are negotiated between buyers and sellers. Physical natural gas contracts share some standard specifications, including 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 points, the tenure of the contract (usually expressed in a number of days, beginning on a specified day) and other terms and conditions.
Spot (Cash) Market – The European natural gas marketplace has a highly competitive spot market where traders buy and sell natural gas daily in short-term deals for next-day delivery. Spot market transactions are normally conducted on electronic exchanges or by telephone, with the buyer agreeing to pay a negotiated price for the natural gas to be delivered by the seller at a specified point on the next day.
B.) THE FINANCIAL MARKET
In addition to trading physical natural gas, there is a significant market for natural gas derivatives and financial instruments in Europe. In the financial market, market participants are interested in profiting from the movement of the price of natural gas rather than delivering or receiving natural gas. The pricing and settlement of these financial products are tied to physical natural gas.
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.
The most important exchange-traded platform for natural gas in Europe is the Intercontinental Exchange (ICE), which offers a wide range of derivative products, both physically and financially settled.
These products include futures contracts and options. As stated by ICE, futures contracts are for physical delivery through the transfer of rights in respect of natural gas at the trading hub. For a given frequency, delivery is made equally each day throughout the delivery period.
OTC markets provide market participants with great flexibility by offering the possibility of tailoring derivative instruments to better fit individual hedging and risk management needs. Specifically, in the case of natural gas trading, OTC markets permit to adapt contract size, location, time of delivery and form of delivery, whether physical or cash settled quality or heating value.
Futures contracts are standardised exchange-traded forward contracts. However, unlike forwards, where the payment occurs at maturity, futures are" marked-to-market" on a daily basis. That is, participants in the futures market have to adjust their positions by making partial payments to the exchange that reflect changes in the current futures price for the specified maturity.
Since the exchange works as a clearing house for futures contracts, participants on the exchange are not exposed to multiple counterparties and their associated credit risk.
C.) GAS HUBS
The natural gas hub is a key pipeline transmission and distribution network element. Typically, a hub is a specific point where pipeline interconnections allow gas transfer from one pipeline to another. Hubs also provide a convenient location to establish natural gas prices.
Natural gas prices depend on a range of economic and non-economic supply and demand parameters, including weather conditions, proximity to production, transmission constraints, geopolitical factors and import diversification. Power plants are the fastest-growing users of natural gas since natural gas-powered plants are more environmentally friendly than coal or oil-based plants.
| THE MOST SIGNIFICANT HUBS FOR NATURAL GAS IN EUROPE | ||
|---|---|---|
| TTF | Title Transfer Facility | The Netherlands |
| NBP | National Balancing Point | The United Kingdom |
| THE | Trading Hub Europe | Germany |
| CEGH | Central European Gas Hub | Austria |
| PSV | Virtual Exchange Point | Italy |
| ZEE | Zeebrugge Platform | Belgium |
| PEG | Gas Exchange Point | France |
| CDG | Single Balancing Point | Spain |
D.) SPOT AND FORWARD PRICES
Spot markets are prices for immediate delivery, whereas future markets are for delivery for some time in the future. These are two very distinct markets that are fundamentally different in the natural gas market.
In the spot market, the prices are the supply at hand and demand at hand; if there is a shortage, then prices can act erratically, as it is difficult to move extra supply from storage on such short notice. In comparison, the futures market is less volatile, mostly being determined by macroeconomic variables of seasonal supply and demand expectations.