The Natural Gas Market

As recently as the early 1980's, the US government imposed stringent price controls on natural gas. For years, gas was believed to be a vanishing resource which should be reserved for residential and light commercial use.³⁸ In 1978, however, perhaps realizing that price controls were contributing to the severe gas shortages which characterized the mid to late 1970's, the Carter Administration proposed and won a hard-fought passage of the Natural Gas Policy Act (NGPA) of 1978 which phased out price controls on natural gas by 1985. Once the artificial price barriers were removed, competitive, economic factors could steer the market, creating an opportunity for an exchange-traded futures contract. Today, natural gas is actively traded both on the NYMEX as well as OTC, allowing risk manage­ment opportunities for producers, refiners and end-users and giving rise to intermediation opportunities — a role filled by varied financial and brokerage firms, including banks.

Unlike the market for crude oil, the North American natural gas market is purely a domestic market. Natural gas accounts for nearly a quarter of all energy consumption in the US. It is primarily produced from reserve basins in Texas, Louisiana, and Oklahoma. These three states account for approximately 70% of total North American natural gas production.³⁹ Alberta, Canada is also a significant producer. Due to recent pipeline expansions, approximately 10% of US demand is met by Canada. The states with the highest net receipts of natural gas include Illinois, California, and New York. Consumption in these states typically exceeds local production.

Overseas natural gas markets will most likely continue to be segregated from the North American market in the near future, primarily due to transportation logistics. Markets that are geographically isolated from pipeline connections can acquire natural gas in the form of liquefied natural gas (LNG). However, imports of LNG to the US are very marginal due to the high costs of transportation and handling. The cost to liquefy and unliquefy natural gas is pro­hibitively high relative to the total cost of the product. Consequently, LNG would only be used as a last resort in periods of peak demand.

The North American market is connected via a network of pipelines. However, local markets can be segregated due to geographic barriers. For instance, difficulties in building pipelines through mountainous regions have effectively severed the California market from other domestic markets. The relative isolation of the Californian (or Western) market, in combination with other factors such as weather, often result in substantial price variation from other regions. This factor was largely responsible for the introduction in 1995 of an exchange-traded natural gas contract specifically for the Western US on the Kansas City Board of Trade.