Introduction to Natural Gas Trading Hedging
Day 1

Natural Gas Risk and Forward Prices

Enterprise Risk

• The concept of risk
• Categories of risk faced by energy companies
• Interdependence of risk in the energy enterprise
• Identifying price risks

The Dealing Process

• Bid-offer spreads
• Role of brokers, dealers and market makers

Forward Pricing Concepts

• Arbitrage discipline in forward pricing of commodities
• Understanding why natural gas prices deviate from theory
• Limitations to the ability to arbitrage
• The ‘Fear Factor’: physical (delivery) risk

The Forward Price Curve for Natural Gas

• Seasonality • Synthetic forwards
• Long-term backwardated and contango natural gas curves
• Valuing and marking to market risk position using the forward curve
• Using the forward price curve to develop hedge tactics
• The role of forward prices in capital budgeting

Swap Structures in Natural Gas

The Financially Settled Contract

• The swap structure • Indifference between Index cash flow and physical natural gas
• Advantages of the swap hedge versus fixed-price physical
• Understanding box and arrow swap hedge diagrams
• Unbundling and separating physical risk from financial risk
• The swap as the collapse of two physical trades • Calculating the all-in pricing with a swap
• How swaps are quoted

Pricing a Swap

• Creating a fair value exchange
• The role of the forward price curve
• The index price reference

Swing Swaps

• Intra-month swaps referencing Gas Daily prices • Calculating a Gas Daily Average
• Balance of Month (BOM) swaps

Location Basis and Basis Trading Structures

Understanding Location Basis

• Defining location basis
• Basis as synthetic transportation cost
• Basis risk

Basis Trading Structures

• The basis swap in natural gas
• Pricing basis trades from price curves
• Quoting convention for basis swaps in natural gas
• Basis spreads in natural gas vs. basis swaps
• Quoting basis spreads
• How a basis swap and a basis spread lock in transport cost

Using Basis Swaps to Price Natural Gas

• The basis risk of hedging at the Henry hub
• Using the basis swap to secure a fixed-price for gas
• Benchmark pricing for natural gas
• Adjusting gas prices for non-benchmark gas sales

Using Basis Swaps to Optimize Risk Taking

• Synthetically relocating risk exposures
• Selling Rocky Mountain gas indexed to Appalachian prices
• Multiple fuel basis-like swap structures
• Selling Rocky Mountain gas indexed to MISO power prices

Day 2

Basis Trading & Natural Gas Pipeline Transport

Basis Spreads and Pipeline Transportation

• Cost of moving gas financially
• Understanding pipeline tariffs
• Calculating fuel charges and capacity gross ups
• Total cost of moving gas using the pipeline
• Pipeline capacity as a long basis position
• Pipeline capacity as a long option position

Review of Option Basics

• Option as payout asymmetries
• Structure and payouts of calls and puts
• Hedging natural gas risk positions with options
• Cost/revenue profiles of risk positions hedged with calls or puts

Options on Basis

• Calls and puts on basis spreads
• Identifying embedded options
• Basis options embedded in supply contracts
• Real options

Pipeline Capacity as Option on Basis

• Pipeline capacity owners have a long call on basis
• Pipeline as a ‘chooser’ option

Swing Swaps and Swing Swap Options on Basis

• Gas Daily swaps
• Gas Daily basis swaps
• Options on Gas Daily basis spreads

Pipeline Segmentation

• Implied transport cost embedded in a price of delivered gas
• Cost minimization using basis swaps
• Choosing between pipeline and basis transport for pipeline segments
• Backhauling as transport arbitrage to reduce transport cost

Time Spread Trading & Storage

Time/Calendar Spreads

• Time spread and seasonal spreads
• Buying and selling a time spread

Storage and Time Spreads
• Storage as a long time spread position
• Time spread as a cost of synthetic storage
• Adjusting for time value of money
• Comparing the cost of storage vs. using time spreads
• Storage as an option on time spreads

Storage Arbitrage
• Arbitrage opportunity because forward gas price is not arbitrage-free
• The cost of storing synthetically
• Packaging synthetic storage
• Synthetic storage as lending

Managing Storage Using Time Spreads
• Using storage to fix a time spread
• Increasing storage margins using time spreads
• Swing swap options as alternative to storage

Short Term Storage Strategies

• “Park-and-Loan” programs
• Intentional imbalance to extract value

Hedging Risk with Natural Gas Futures

The Henry Hub Natural Gas Futures Contract

• Origins of futures exchanges
• The natural gas contract
• Contract specifications

Margining and Credit Risk

• Default risk mitigation
• Original margin
• Maintenance/variation margin
• Exchanging credit risk for cash liquidity risk
• Implications of margins on cost

Using Futures to Hedge
• NYMEX Standard Delivery
• Delivery procedure
• Alternate delivery procedure
• Futures as a ‘paper’ hedge
• Managing cash-futures basis
• NYMEX “Look-Alike” swaps
• Comparing futures against swap hedges

EFP’s and EFS’s

• Exchange of Futures for Physical (EFP)
• Execution risk with futures when dealing away from the Henry Hub
• Pricing and executing an EFP
• Exchange of Futures for Swaps (EFS)
Other Floor Traded Natural Gas Products

• Options
• Strips

Natural Gas On-Line Trading

• Henry Hub swap futures (outrights)
• Henry Hub Penultimate swap futures (outrights)
• Index swap futures
• Basis swap futures
• Swing swap futures

Clearing OTC Transactions

• Managing Over the Counter Credit Risk

Trading Simulation

Understanding Trading Concepts

• The dealing process
• Understanding and working under VaR trading limits
• Factors affecting natural gas prices
• Storage levels
• Weather
• Reading and understanding historic price charts
• Developing trading strategies
• Performance metrics
Trading Game Sessions


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