Now that the winter of 2012-2013 is behind us, its a great time to look at the settled basis values between the settled spot prices for the Algonquin Pipeline City Gates and the Henry Hub delivery point for the NYMEX contract. Anyone familiar with FASB 133 hedge accounting rules knows that basis risk is a major determinant as to whether a hedge will be effective in mitigating price risk. As a quick refresher, basis is simply the price difference for a commodity between the delivery point for the standard financial contract and the delivered cost of the physical commodity in a geographic region.
The graphic below shows the monthly average settled prices of spot gas delivered via the Algonquin City Gates. As you can see, the prices experienced in Jan-Feb 2013 are not unprecedented. Similar prices have also been experienced in the aftermath of Hurricane Katrina, the 2008 price bubble, and sporadically during cold winter months (e.g., Jan 2001, Jan 2004).
The aspect of this winter's prices that is truly unprecedented is the degree to which basis has comprised the majority of the cost of delivered gas. In previous high price environments for delivered spot gas in New England (e.g., post Katrina, 2008) the NYMEX prices were similarly elevated. In the past several months, that has not been the case and New England has had very high spot gas prices while the NYMEX has been below $4/MMBTU. The graphic below shows historical settled basis spreads between the Algonquin City Gates and the NYMEX Henry Hub. You can clearly see that this winter is unique.
New England is now in a unique situation where the winter basis actually costs more money to hedge than the actual natural gas commodity itself. If one were to do a financial hedge on natural gas alone in 2014 or 2015, it would not be an effective hedge due to the outsized role basis plays in the delivered cost of natural gas in Southern New England. As a result, the only real hedging tool available to most end users is the NYMEX + Basis pricing option available through an energy marketer. The graphic below shows the cost to hedge delivered gas on the Algonquin City Gates. It is color coded to show the relative contribution of basis and the NYMEX contract to the total delivered cost. If you look closely, you'll see that the basis forwards are actually backwardated. The expectation is that pipeline expansion and debottlenecking projects throughout the Northeast will ameliorate the winter constraints in the marketplace by 2015, but only time will tell if this expectation is correct.