Part 1: Spot Prices and Market Basics [Series: Natural Gas Investment]

You care about natural gas prices. Probably because you suspect, correctly, that they affect your paycheck somehow. You buy natural gas, and so does your employer, so they getcha coming and going. But you’re used to that, as a good, hard-working American. You’re always taking it somewhere, somehow. In fact, I’m going to tell you about how natural gas prices are tied up with something called a “crack spread.” NO JOKE Y’ALL. This is serious work, right here. So buckle up, little camper: this is the first in a series of posts about price discovery, commodities trading, and all kinds of super fun Investment Facts about natural gas.

How important is natural gas?

First, you should know that natural gas is closely, deeply, intimately, creepily tied up with US economic growth. Here’s how natural gas is used in the US:

  • Provides 25% of US electricity generation. Which powers, what, like half of the energy required for Internet pron-viewing.

  • Used for heating, cooling, and cooking. You need that for corn dogs and stuff.
  • Industry accounts for nearly half of all natural gas consumption in the US:
    • It’s used in paper/pulp, metals, chemicals, petroleum refining, clay and glass, plastics, and food processing industries.
    • It’s used in industrial drying, heating, and cooling processes.
    • It’s used as a feedstock (raw material) for the manufacturing of important industrial chemicals and products. This includes agrochemicals, lubricants, adhesives, anticorrosives, etc., as well as cosmetics, pharmaceuticals, and packaging.
    • So pretty much everything ever.

What’s likely emerging from your brain-fugue at this point is just how much the US economy depends on natural gas.

So really, really important, then. So what?

What happens in natural gas markets has a great deal to do with why politicians get all Crazytown over environmental regulations on natural gas. Any time the EPA even casually MENTIONS stricter regulations on natural gas production, like just over a drink or something, politicians immediately stop sexting interns and say weird shit like: “Environmental regulations are bad for America!” Because anything that might make natural gas more expensive directly impacts manufacturing, which is important to the US economy, not to mention getting elected. So, how do natural gas markets work, you ask?

Spot Prices at the Henry Hub: Ladies’ Night Every Thursday!

No, the Henry Hub is not a skeezy bar. It is a gigantic ugly natural gas pipeline hub in Erath, Louisiana. It connects with 4 intrastate and 9 interstate pipelines, so as a physical distribution point, it’s one of the most important in the US. The spot price of natural gas is the price at which natural gas can be bought or sold right now at the Henry Hub. So it’s a baseline price for natural gas across the market. It’s easier to think of the Henry Hub spot price as an index of natural gas price fluctuations, rather than as the price of the gas itself. Kind of analogous to the Dow Jones Industrial Average. Which no one really understands either.

Some of the things that affect spot prices are weather, overall supply, economic growth, storage prices, and fuel competition. For instance, the hottest and coldest months result in higher demand for natural gas. More importantly, we’ve seen that a great deal of physical manufacturing in the US depends on natural gas. So, in times of greater economic growth, manufacturing industries will demand more natural gas. Competition is also a factor in natural gas markets. Natural gas competes with other fossil fuels, because significantly many manufacturing facilities can fuel-switch among natural gas, oil, and/or coal. Natural gas also competes to a certain extent with coal in the electricity-generation market.

All of the above factors affect natural gas markets, causing spot prices to fluctuate, which complicates manufacturers’ decisions about what they’ll make and when. Like, what if you want to roll out a new product in a year? You need to know how much gas you can buy and what your costs will be to make it. But you don’t know how much gas will be in 6 months, so there’s a lot of risk involved in waiting to buy it right when you need it. But it also costs a lot to store it, which could wipe out any savings you get from buying it early.

So, how do you hedge that risk? And how do we make sure everyone is working off reliable information when making plans? One way to hedge risks in petroleum markets is through futures contracts and other derivatives. Stay tuned for Part 2 to learn about these!

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