Natural Gas

The NYMEX natural gas contract (the first natural gas futures contract in the world) began trading on April 3, 1990 and options were added on October 2, 1992. Options expire one day prior to the futures contract in order to facil­itate convergence of the exchange price to the cash market price during bid week. The contract is the fastest grow­ing in the NYMEX's 121-year history.¹⁹ It is based on delivery at the Henry Hub, connection point for 12 pipelines, in Erath, Louisiana. The intricate pipeline transportation system in the US gives rise to numerous basis issues for users of natural gas who require delivery at a location not directly served by those pipelines and will be more fully discussed later in this product summary.

Natural gas futures trades are not as voluminous as crude oil, with an average of about 20,000 contracts traded each day. Futures are listed for eighteen consecutive months (though the exchange has received CFTC approval to list contracts of 21, 24 and 36 month maturities), while options contracts trade for twelve consecutive months. Natural gas futures trade on the NYMEX's ACCESS^SM electronic trading system from 4 pm to 7 pm Mondays through Thursdays. There is little need for longer market hours since, unlike crude oil, there is no active international market which serves as a good proxy for the US contract.

On August 1, 1995, the Kansas City Board of Trade (KCBT) launched a Western Natural Gas Futures contract based on delivery at the Permian/Waha Hub in west Texas. The hub connects ten pipelines and facilitates delivery to California and the Midcontinent. The logic behind introducing a futures contract with a different delivery point than the NYMEX contract was to offer hedgers the ability to hedge against a different geographic location, thus lessening the basis risk of a hedged trade. For instance, it would not be unusual for the East Coast to experience a severe winter while the West Coast was balmy. Thus, higher prices for gas would prevail in the East while prices in the West may stay steady or even fall. A West Coast producer who was hedged to the NYMEX might see that hedge quickly deteriorate as the basis between the NYMEX futures contract and spot West Coast prices widened con­siderably. The KCBT contract was designed to give hedgers an alternative to hedging only to an East Coast location. It is too soon to gauge the success of this contract. Since inception, daily volume has only been about 500 contracts/day in the front month. However, the basis between the two contracts is not stable, suggesting that two contracts may ultimately prevail in the US market. (The NYMEX is presently gearing up to list a competing contract.) Exhibit 4 plots the spread between the NYMEX and KCBT natural gas contracts for the period 9/25/95 through 11/22/95 (NYMEX minus KCBT in cents).

Exhibit 4

NYMEX vs. KCBT Natural Gas

Sep. 25 through Nov 22, 1995

$0.20

iep 25 Oct 4 Oct 13 Oct 24 Nov 2 Nov 13 Nov 22