The Henry Hub futures contract is one of the most traded natural gas futures contracts in the world due to its price transparency and robust liquidity. As the delivery point for Henry Hub futures, the Henry Hub, located in Erath, Louisiana, is a nexus of several interconnections with interstate and intrastate pipelines and related infrastructure. As a result of this level of interconnection, Henry Hub offers natural gas shippers and marketers ready access to pipelines serving markets in the Midwest, Northeast, Southeast and Gulf Coast regions of the United States.
The purpose of this article is to highlight the trading characteristics of Henry Hub futures and the infrastructure relevance of the underlying delivery point, which have enabled this contract to become the benchmark or de facto price reference for the US natural gas market.
The structure of the US natural gas market has evolved over time and become in essence the most competitive, efficient, transparent, and liquid natural gas market in the world. In the late 1980s and early 1990s, the deregulation of natural gas wellhead prices revolutionized the US natural gas industry and transformed the wholesale natural gas market. Market liberalization allowed the price to be determined based on market dynamics and demand and supply interaction. Additionally, natural gas spot transactions moved from wellheads to hubs which started offering various physical services and products to different market segments including marketers, local distribution companies (LDCs). Spot trading around hubs and market centers started to flourish and the pool of market participants expanded. These changes led to a highly competitive and efficient natural gas marketing and wholesale market.
In April 1990, NYMEX played a groundbreaking role by introducing the Henry Hub Natural Gas Futures as a risk management and price discovery mechanism. The product was designed to mirror commercial practice and the underlying physical market. It allows the “monetization” of natural gas for future delivery through standardized transactions. Holding a position in this contract will result in taking or making delivery of the actual natural gas at Henry Hub unless the open position is closed before expiration. The delivery process resulting from the futures contract represents the linkage between the physical market and the financial market.
As the first standardized natural gas futures contract, Henry Hub futures became the catalyst for the growth of financial natural gas trading in the US. Unlike the physical market, the futures market offers price discovery across time reflected in the term structure or the forward curve. The futures contract is listed on a monthly basis for the next twelve years, allowing visibility of market expectations for future natural gas prices. Henry Hub is utilized as the pricing preference for essentially the entire North American natural gas market. Other US natural gas locations are basically priced at a differential to Henry Hub to account for regional market conditions, transportation costs, and available transmission capacity between locations.
The Henry Hub futures contract is the world’s most traded natural gas futures contract. The high liquidity of Henry Hub futures provides market participants with easy access to either enter or liquidate positions. As shown in Chart 1, daily volumes currently average 575,607 futures contracts compared to 293,432 in 2014. Daily volume reached a record level of 1,039,442 contracts on March 10, 2020. The depth of liquidity, which is reflected by extensive participation by market participants, has enhanced the price discovery function of the contract.
The commercial relevance of Henry Hub is the result of its strategic location and logistical infrastructure. This physical aspect is a crucial component to be understanding the role of Henry Hub futures as the pricing benchmark for the natural gas market.
Henry Hub is strategically situated in a major onshore production region and is at close proximity to an offshore production area as well. As indicated in chart 2, the monthly average natural gas production in Texas has been increased from 585,016 MMcf in 2017 compared to 665,418 MMcf in 2019. This represents 28% of US marketed production, making Texas the state with the highest natural gas production. State production levels have grown in recent years due to increased drilling activity from shale formations, in particular the Eagle Ford, Barnett, Haynesville, and Permian basin in west Texas.
In addition, the region has also relied on natural gas produced in the Federal Offshore region. Chart 4 shows that the monthly average offshore natural gas production has decreased over the years from 89,758 (MMcf) in 2017 to approximately 81,943 (MMcf) in 2019.
As indicated in chart 3, Louisiana produced a monthly average of 177,324 (MMcf) in 2014 compared to an average of 262,279 in 2019 . This represents 9% of US marketed production. Louisiana production comes from two geologically different regions: South and North. Most of the natural gas produced in the North is from the Haynesville shale play, while most of the natural gas produced in the South is from associated gas (oil rigs) and the offshore area.
In addition to the ample supply that is available and accessible, the Southwest region has one of the most developed and extensive pipeline networks in the country. This allows natural gas to be moved from supply basins and exported to major consumption markets. This highly integrated network is served by both interstate and intrastate natural gas pipelines. In Texas, intrastate and interstate natural gas pipelines1 span over 45,000 miles and 13,000 miles respectively. Louisiana’s distribution system also plays a pivotal role in delivering natural gas to major markets via several interconnections to interstate and long haul pipelines such as the Texas Gas Transmission Company and the Trunkline Gas Company.
Henry Hub is owned and operated by Sabine Pipe Line LLC and its affiliates as a full-service header system which offers various receipt and delivery capability, hub management services, and an extensive interconnection to one of the most important US pipeline structures.
Sabine Pipe Line is a bidirectional mainline pipeline that stretches from Port Arthur, Texas to the Henry Hub near Erath, Louisiana. As an interstate pipeline that is certified as an open-access gas transporter, it is directly connected to four industrial consumers and one producer. Through its transportation program, Sabine provides transportation services for both the Henry Hub and Sabine’s mainline. This allows a shipper to transfer gas from one pipeline to another. In addition, the hub offers a variety of hub services such as balancing to cover short-term natural gas needs and title transfer, which involves the progression of natural gas ownership from party to party.
Henry Hub is interconnected to eight interstate pipelines and three intrastate pipelines. These pipelines are part of the highly integrated US transmission grid, which transports natural gas from production and processing areas to storage facilities and distribution centers and then onto consumption markets. A schematic of Henry Hub is included below.
The region also has an extensive offshore gas pipelines, which move natural gas from Deepwater areas to onshore gathering and processing plants. Actually, the region is currently experiencing significant developments in midstream business and pipeline infrastructure to displace the excess shale gas to new markets.
Henry Hub also has a direct connection to storage facilities, including Jefferson Island, Acadian, and Sorrento. These facilities are salt-dome caverns characterized by high-deliverability and high cycling rate, which allow for several withdrawal and injection cycles each year. Additionally, Henry Hub has access to other storage facilities in the region through interconnected pipelines. The region already has significant storage sites while many others are in the process of development. These facilities represent a fundamental conduit that offers flexibility in withdrawals and injections based on demand and supply dynamics to meet the needs of the Southwest region or other regions. Chart 5 exhibits the underground storage volume collated by the EIA for Texas and Louisiana where there are more salt-dome facilities than any other part of US. During the injection season of 2019 (April-October), total stock levels reached 3,909,297 MMcf and 4,537,959 MMcf in Louisiana and Texas respectively. These levels represent 8% for Louisiana and 10% for Texas of US total storage volume during both seasons.
From a demand perspective, the US Gulf Coast (“USGC”) is undergoing a fundamental shift and becoming a major consumption destination. The abundant natural gas and the low-price environment has transformed fuel economics and has increased the use of natural gas as a feedstock by the electricity, industrial and export sectors. According to the EIA, natural gas was the largest fuel source for US net generation of electricity by reaching approximately 4.1 trillion kilowatt hours (kWh) in 2019. this figure is expected to increase due to high coal-to-gas switching, the retirement of coal-fired generators, and environmental regulations. Specifically, Texas is turning to more natural gas to meet its growing power generation demand and is building considerable number of natural gas-fired power plants. On the other hand, natural gas demand from the industrial sector (e.g., fertilizer, petrochemical, and steel) is noticeably expanding. Most of the significant investments and infrastructure expansion projects are situated in Texas and Louisiana.
The shale revolution has profoundly changed the market landscape and paved the way to export opportunities in order to absorb the surplus. The U.S. is now the largest natural gas producer in the world. This is due largely to the rapid drilling technological development which was prompted by the shale renaissance. These advancements have substantially enhanced the productivity and have cut costs per well. Chart 6, US production growth is expected to reach 45 Tcf by 2050.
The significant changes in underlying fundamentals have created excess supply and led to a commercial incentive to liquefy natural gas. This can then be transported in special cooled vessels to new baseload demand destinations across the globe to capture any arbitrage opportunity.
US LNG export projects have started to develop as a direct result of the new market reality reflected in the abundance of natural gas and the emergence of new global demand sources.
Most U.S. LNG export projects are situated in the Gulf of Mexico, except Cove Point which is in the northeast. As the first mover in the U.S., Cheniere’s Sabine Pass (“SPL”) terminal in Cameron Parish in Louisiana started exporting LNG in February 2016. The Sabine Pass LNG terminal includes liquefaction facilities which are adjacent to the existing regasification facilities. SPL receives natural gas at multiple interconnections, including Creole Trail pipeline, which is owned by Cheniere Partners and spans over 94 miles. The terminal also interconnects with interstate pipelines including the Natural Gas Pipeline Company of America (‘NGPL”), Transcontinental Gas Pipeline Corporation (“Transco”), Tennessee Gas Pipeline Company, Florida Gas Transmission Company, Bridgeline Holdings, L.P., Texas Eastern Gas Transmission (“TETCO”), and Trunkline Gas Company (“Trunkline”). SPL is one of the largest pipeline capacity holders in the U.S. As of December 31, 2019, SPL had contracted approximately 4,000 TBtu of natural gas feedstock through long-term and short-term natural gas supply contracts.
Cheniere also exports LNG from the Corpus Christi LNG (“CCL”) terminal in Texas which is the first U.S. greenfield LNG project. The facility owns a 23-mile natural gas supply pipeline – the “Corpus Christi Pipeline” – that interconnects with multiple interstate and intrastate pipelines including South Texas, including Tennessee Gas Pipeline, Kinder Morgan Tejas Pipeline, Transcontinental Gas Pipeline, Natural Gas Pipeline Company of America and Enterprise Products Operating LLC. Cheniere is also building another pipeline.
Cheniere is considered to be the world’s second largest LNG exporter after Qatar Petroleum as its export volume reached more than 70 million tonnes, equivalent to 1,000 cargoes, from both terminals as of December 2019.
Cameron LNG (“CLNG”) terminal is jointly owned by affiliates of Sempra LNG, Total, Mitsui & Co., Ltd. and Japan LNG Investment, LLC, a company jointly owned by Mitsubishi Corporation and Nippon Yusen Kabushiki Kaisha (NYK). The terminal is located in Hackberry, La. CLNG receives natural gas feedstock via Sempra’s Cameron Interstate Pipeline which runs from CLNG in Cameron Parish and follows a route along Calcasieu Parish, terminating at the Ragley Compressor Station in Beauregard Parish. The pipeline has multiple interconnects with the Florida Gas Pipeline, Tennessee Pipeline, Texas Eastern, and Transco. CLNG has obtained approval to export up to 14.95 million tonnes per annum (Mtpa) or approximately 2.1 billion cubic feet (Bcf) per day.
Freeport LNG (“FLNG”) terminal is jointly owned by Freeport LNG limited partnership and other investors. FLNG terminal is located on Quintana Island on the west side of the Freeport Channel and south of the Intracoastal Waterway. FLNG procures natural gas via from interconnects with intrastate pipeline systems, e.g., Dow Pipeline Company; Kinder Morgan Texas Pipeline, L.P.; Brazoria Interconnector Gas (BIG) Pipeline; or other yet-to-be-built pipeline(s), through Freeport LNG's existing Stratton Ridge meter station. The terminal has a capacity of 1.98 billion cubic feet per day (Bcf/d) baseload (2.14 Bcf/d peak capacity).
Several other brownfield and greenfield LNG projects are under construction and are expected to come online in the next few years. Most of these anticipated developments are located in the Gulf of Mexico, which offers a concentration of infrastructure capabilities and robust production. Additionally, the recent expansion of the Panama Canal provides an opportunity for U.S. Gulf Coast LNG to be economically shipped to the Pacific Basin.
One of the most important implications of the U.S. LNG export projects is the rising influence of the U.S. Henry Hub price on global gas prices. Historically, the oil-indexation pricing mechanism was a cornerstone of LNG long-term contracts especially in Asia. LNG was linked to oil prices with a three or four-month lag. However, this mechanism has failed to accurately reflect the fundamentals of the gas market and limits the possibility of arbitrage. Due to these shortcomings, European Union energy policies and major suppliers have started to substitute oil index contracts with hub-based ones. Since 2015, Asian buyers have also sought to diversify the pricing structures of their LNG agreements, shifting away from long-term oil-linked contracts with traditional fixed-destination clauses.
Cheniere was the first US supplier to introduce a Henry Hub-linked LNG formula. This formula is based on off-takers that are contracted to lift LNG and pay an approximate fixed fee between $2.25 to $3.5 per MMBtu plus a charge of 115% of the Henry Hub price. The fixed “take-or-pay” fee is paid irrespective of lifted volume and can be considered as a sunk cost. The Henry Hub price and 15% charge represent the cost of procuring feedstock gas that is variable depending on the volume lifted. Shipping and re-gasification costs are covered by the downstream participant or off-taker. An important implication of such a structure is that the trading determination process is driven by the spread or margin between Henry Hub versus regional spot LNG prices and the variable costs (shipping, regas) while ignoring the fixed fee which is considered as a sunk cost.
In conclusion, due to its ample natural gas supply, robust infrastructure, sound financial system, and well-developed commodity trading apparatus, the U.S. is becoming a major LNG player, which will make Henry Hub an even more important price reference in global gas trading.
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