It is very common for marketers to hedge their customer sales. But, are you REALLY hedged? Many marketers make a forward fixed-price sale and immediately go out and buy some type of fixed-price hedge. That is a wise move, but it is only part of the equation. Unless you buy the hedge at the location where you require the natural gas (i.e., Transco Station 85, Texas Eastern M2, etc.), you are leaving yourself open to locational risk, commonly referred to as basis risk.
What is basis? Basis is the differential between the forward value of gas at the Henry Hub (which is the point at which the Nymex contract trades) and the value of gas at a different location, say Texas Eastern M2.
For example, if the Nymex is trading $3.00 for December 2019 and the value of Texas Eastern M2 gas for December 2019 is $2.50, then the basis between Texas Eastern M2 and the Henry Hub is minus $.50 ($2.50 minus $3.00) for that day.
Why is this important? Everyone knows the Nymex can, and usually does, move each trading day. The same is true of basis. And what’s more, the movement in basis can be just as volatile as the movement in the Nymex. Notice that I mentioned above that the basis between Texas Eastern M2 and the Henry Hub was minus $.50 FOR THAT DAY.
Using our example above:
You purchase a Nymex contract for December 2019 at $3.00 believing your fixed price sale to be hedged. With the Texas Eastern M2 basis trading at minus $.50 at that time, you have in essence hedged a price of $2.50 at Texas Eastern M2.
When the December Nymex contract finally settles, it has advanced to $3.25 and you are thanking your lucky stars that you hedged that sale.
However, what if at the same time the Texas Eastern basis has risen from minus $.50 to minus $.35? Now the value of gas at Texas Eastern M2 is $3.25 minus $.35, or $2.90 an increase of $.40 above the value on the day you purchased your $3.00 Nymex contract.
Unfortunately, your Nymex contract has only increased in value by $.25, so even though you “hedged” your sale, your overall cost is now going to be $.15 greater than when you purchased the $3.00 Nymex contract.
The moral of the story…
Unless you acquire your gas at the Henry Hub, buying a Nymex contract does not make your sale fully hedged. Take one extra step and hedge your basis also.