Natural Gas plays a crucial role in conserving the only planet we dwell in. Replacing dirty fuels with natural gas protects the earth from overheating and global warming. Switching from coal to gas is essential. Generating electricity from gas improves air quality and limits carbon emissions. 

Natural gas was once simply considered a by-product of crude oil. Increasingly it is one of the cleanest burning fossil fuels and a key element towards energy transition. Today, natural gas forms the backbone of the global energy mix.

This paper introduces the uses, supply-demand dynamics, and impact of seasonality on natural gas prices. It also articulates the rise of the U.S. as the world’s largest producer and a major key exporter, which further reinforces Henry Hub Natural Gas as a global benchmark.

Natural gas is considered the transition fuel for a clean energy future. It is relatively cheap compared to other fuels due to its abundance. Its versatile uses include mainly heating/cooling for residential and commercial sectors, power generation, and industrial usage.

There are three primary demand drivers for natural gas:

1. Electricity production (as gas replaces dirty coal)
2. Commercial and residential heating (gas is used for heating homes in winter), and 
3. Industrial use (gas is used as raw material for industrial products such as plastics, ammonia, and methanol)

Natural gas demand is heavily influenced by weather. Warm summers in the Northern Hemisphere drive higher energy usage for cooling. Colder winters drive demand for heating.

In 2022, natural gas was the main fuel source for U.S. power generation. This is expected to grow even more with continuing coal-to-gas switching, closure of coal-fired generators, and environmental regulations.

The U.S. is the largest natural gas producer. Other top producers include Russia, Iran, China, Canada, and Qatar. Russia is the largest exporter. Next to it, the U.S., Qatar, Norway, Australia, and Canada are among the top exporters, too.

The U.S. shale reserves have a high concentration of natural gas. Along with newly developed fracking techniques, this has led to increasing gas production in the U.S. Moreover, gas is also obtained during oil extraction. Consequently, gas production is tightly linked to oil production.

This has interesting ramifications when assessing present conditions. Despite low gas prices, production in the U.S. has remained elevated thanks to high oil production. Higher prices do not equate to higher production, indicating inelasticity between gas prices and supply.

Post Russia-Ukraine conflict, Russian exports plummeted 58% in 2022. This led to price shocks in EU natural gas (TTF). U.S. supply cannot adequately bridge this deficit as transporting gas via ships requires converting it to Liquified Natural Gas (LNG) and using special refrigerated vessels, which is not economical for enormous quantities. 

This explains the wider spread between EU and U.S. natural gas relative to EU and U.S. oil, respectively.

The U.S., Russia, China, Iran, and Canada are the top natural gas consumers. China, Japan, Germany, the U.S., and Italy are its top importers.

What makes the U.S. the largest natural gas producer among the top natural gas importers? To answer this question, we will need to deep dive into Henry Hub to understand how it has transformed the natural gas market as a global benchmark. 

The natural gas imports to the U.S. by pipeline are chiefly from Canada. These support seasonal fluctuations in natural gas consumption in the U.S., usually peaking in January or February. LNG imports are delivered to the New England market where imports are a marginal source of natural gas supply during periods of high demand, particularly in the winter months.

Driven by Henry Hub, the U.S. natural gas market has undergone a remarkable transformation over time, evolving into one of the most competitive, efficient, and transparent markets in the world.

Going back in time, gas distribution companies have always been subject to regulation. Amid growing concerns over the heavy concentration in the natural gas market and the monopolistic tendencies of gas pipeline companies to charge higher due to their market influence, the U.S. government passed the Natural Gas Act in 1938.

Protecting consumers from unreasonable pricing was the objective of the new legislation. The Act gave the Federal Power Commission (FPC) the authority to regulate transportation, sale, and pricing. 

The Department of Energy Organization Act of 1977 transferred FPC's regulatory role to the Federal Energy Regulatory Commission (FERC). In 1989, The U.S. Congress deregulated natural gas pricing at the wellhead by passing the Natural Gas Wellhead Decontrol Act.

The deregulation of wellhead prices revolutionized the industry, enabling market dynamics to determine prices. 

This eventually led to the introduction of Henry Hub Natural Gas futures by NYMEX in April 1990. These futures closely mirror the physical market, offering a means to monetize natural gas for future delivery. 

Crucially, they provide a critical link between the physical and financial markets, facilitating risk management, and price discovery not only in the spot market but also across a 12-year forward curve.

The strategic location of Henry Hub near major natural gas production regions (Texas and Louisiana) is instrumental in its role as a delivery point for futures contracts. 

Texas, with its extensive shale formations like the Eagle Ford and Permian basin, has become the leading natural gas producer in Louisiana , the U.S. also significantly contributes to production from both northern and southern regions. 

Henry Hub's interconnections with numerous pipelines make it a vital component of the U.S. transmission grid. It has direct connection to storage facilities, including Jefferson Island, Acadian, and Sorrento, allowing excess gas to be transported for long-term storage.

Over the past decade, the U.S. Gulf Coast has also become a major consumption region in addition to a production region. The U.S. shale revolution led to abundant supply of natural gas in the U.S., which also led to expansion of consumption in the region.

As the U.S. has grown to become the largest producer in the world, the ability to export U.S. gas has become lucrative. The Russia-Ukraine conflict has accelerated this as even more gas was removed from European supply. This has given the U.S. exporters further incentive to expand capacity. 

The LNG export boom in the U.S. is concentrated in the Gulf Coast with a notable exception for projects in the Northeast. It is being driven by Cheniere Energy which was an early mover in the space and has developed liquefaction facilities in Louisiana next to existing gasification plants. Cheniere also holds extensive pipeline access to Henry Hub. 

The rapid expansion and demand for U.S. natural gas has made Cheniere the second largest LNG exporter after Qatar Petroleum. Further, investment in LNG terminals continues to grow. The space is ripe for expansion, but long build times lead to long gestation.

As more plants come online, demand for Henry Hub natural gas will rise further. Additionally, Cheniere, the largest exporter, has developed a Henry Hub linked LNG formula that makes the price of the benchmark even more vital in global gas markets.

Signs of growth in the U.S. natural gas and LNG exports are already visible. As reported by EIA, the U.S. now commands top rank as the world’s largest LNG exporter in H1 2023, rising 4% YoY. Export growth in the U.S. has been exponential and continues to rise.

Most U.S. exports are headed to EU while exports to Asian and South American countries have declined over the past two years. 

Other key natural gas derivatives are TTF in Europe and JKM in Asia. Futures from both regions are also available for trading and risk management from CME Group. 

With the growing role of Henry Hub as a global benchmark, spreads between different contracts are becoming critical. Still, as most natural gas is transported by pipeline rather than LNG, exact arbitrage is not possible. Each contract is affected by idiosyncratic supply and demand factors making spread trades difficult to implement.

Gas can be injected into storage facilities for later use. These inventory levels play a significant role in balancing supply and demand. 

Summer months (April to October) are referred to as injection periods while winter months (November to March) are withdrawal periods. Inventory levels help even out the surge in winter demand. 

However, natural gas is much harder to store than oil as it is less dense. Consequently, inventory effect is not as apparent which explains the larger seasonal swing in natural gas prices relative to oil prices.

Two distinct price rallies characterise seasonality in natural gas. A large rally during winter in the U.S. and EU driven by surge in supply for heating in winters. During this period, prices peak in early-December before declining. 

The other smaller spike is during summers in the U.S. and EU when demand for electricity rises. During this period, prices peak in early June before declining.

Further, prices show the highest deviation from the seasonal trend in late-September.

Over the past five years, the winter rally has become more pronounced, with prices staying elevated from August to early-December.

Traders and portfolio managers navigate market risk using the liquid Henry Hub Natural Gas futures and options. Deep liquid markets enable traders to efficiently get in and out of positions. Natural gas is the third largest physical commodity futures contract in the world by volume. 

Users can tailor hedging and trading strategies with (a) outright trades, (b) calendar spreads, (c) inter commodity spreads, and (d) American, European, or daily options.

Natural gas futures are connected to the spot market. Every day, 400,000 contracts are traded with an average open interest of 1.7 million contracts.

Seasonal trends suggest that prices tend to rise during September and October before declining through the winter. The price surge during October due to near-term volatility provides an entry for a short position in CME Group Natural Gas futures.

A hypothetical short position in CME Group Henry Hub Natural Gas futures expiring March (LNH24) at present level of $3.385/MMBtu will benefit from a seasonal decline in price. 

As per past trends, gas prices post negative returns from November to January. Over the last 10 years, prices have declined 3.5% from October to December. This suggests a target of $3.27/MMBtu.

As each contract of the Henry Hub Natural Gas futures provides exposure to 10,000 MMBtu of natural gas, this hypothetical trade setup represents profit of $1,185. 

Still, note that seasonal trends are not guaranteed, moreover, November and December price action shows high variance in the listed trend.

Gas prices rose 23% in the beginning of October but subsequently retraced some of those gains after declining 11%.

Uncertainty in gas markets and risk of supply shocks from geopolitics is running high. Instead of a directional view using futures, which has unlimited downside, we could consider a back spread options strategy to obtain similar exposure with limited downside.

A back spread consists of one short at the money (ATM) put option and long 2 x 35-delta put options. This results in net delta exposure of -30.

The position breaks even at $2.686/MMBtu (-20.5%). At $2.5/MMBtu (-26%), the position nets a profit of 0.1863 points = $1,863.

Downside for this strategy is highest (0.4637 points = -$4,637) when prices decline slightly. When prices rise or stay flat, downside is 0.2637 points = -$2,637.

Seasonality drives natural gas prices lower in December and January followed by rise between February and June. A calendar spread can be used to harness exposure to this seasonal trend. 

To express our market views, we could consider a spread trade consisting of a short position in CME Group Natural Gas futures expiring in February 2024 (NGG2024), combined with a long position in the Natural Gas futures expiring in June 2024 (NGM2024).

As of 19th October, the NGG2024 is trading at USD 3.647/MMBtu while NGM2024 3.268/MMBtu. One lot of long position in the NGG2024 and one lot of short position in NGM2024 will result in the following payoff: 

1. The calendar spread will make money 

• when Feb contract falls, while the Jun contract rises, 
• when both fall but Feb falls sharper than the Jun contract, or 
• when both rise but Jun contract rises higher relative to Feb. 

2. The calendar spread will lose money 

• when Feb contract rises, while the Jun contract falls, 
• when both fall but Jun falls sharper than the Feb contract, or 
• when both rise but Feb contract rises higher relative to Jun.

Natural gas is one of the cleanest burning fossil fuels and a key element towards energy transition. It forms the backbone of global energy production.

Three primary demand drivers for natural gas are electricity production, commercial and residential heating, and industrial uses.

The U.S. natural gas has transformed over time driven by Henry Hub, evolving into one of the most competitive, efficient, and transparent markets in the world.

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