Introduction
Henry Hub futures are independent standalone commodities that allow market participants to manage risk and hedge against the highly volatile natural gas prices.
Henry Hub is located near Louisiana’s Gulf Coast and is the most important natural gas hub, as here nine interstate and four intrastate natural gas pipelines intersect. It is being used as a pricing reference for futures since April 1990. It also serves as the delivery location for futures contracts on the New York Mercantile Exchange (NYMEX).
Why should you trade Henry Hub futures?
- Global Benchmark: Henry Hub acts as an important price reference in global gas trading as it has a huge supply of gas, robust infrastructure, sound financial system, and highly developed commodity trading apparatus.
- Pragmatic Pricing: It gives a fair price for Liquid Natural Gas (LNG) as the buyers consider Henry Hub as a stable and affordable benchmark.
- Physical Settlement: Henry Hub futures are closely connected to the spot market, therefore, reducing the disparity in spot prices.
- Liquidity: Henry Hub is the third-largest traded commodity and leads other hubs by a significant margin.
Natural Gas: Importance of the Underlying Commodity
According to the 2020 GIIGNL report, there is a growing demand for LNG. This growth, along with the liberalization reforms in major pro-LNG countries, has made derivatives an essential financial tool.
This rise in demand for natural gas is evident from the stats below:
Events and Views that Triggered this Rise:
- Fukushima Crisis: Japan faced an energy crisis during 2011 because of a nuclear plant’s failure, which increased the dependency on LNG to fulfill its energy demands.
- Environment: Natural gas is envisioned as a bridge fuel because of its low emission characteristics as compared to coal.
2010: Growth in volume was because of the improved economic outlook and increased liquidity in the energy futures market.
2012: The increase in volumes was mainly due to volatility around production shifts in the early part of 2012.
2013: An increase in domestic supplies, which resulted in lower volatility, led to a decrease in the volume of natural gas contracts YoY.
2014: Decline in energy contracts is attributed to low price levels resulting from a capacity increase in the United States (US) natural gas sector.
2016: Natural gas volumes recorded a steady increase from 2015 due to high volatility within the energy markets following the Organization of the Petroleum Exporting Countries decision to cut oil supplies and the US presidential elections, which created uncertainty surrounding the new administration’s proposed policies for the energy markets.
2019: Greater price stability within the crude oil markets led to lower price volatility in the overall energy market, which resulted in a decline in natural gas volumes.
2020: Due to COVID-19, there is a lot of uncertainty in market drawdowns, market demand, and oil prices. This will likely result in high Henry Hub futures volumes. Chicago Mercantile Exchange reported 48% YoY increase in Natural gas contracts in H1CY20.
Factors Affecting the Volumes of Henry Hub Contracts
Market Participants
Reforms
Liberalization: Gas market liberalization reforms are on the rise in major Asian markets. The lack of a liquid hub in these markets has made Henry Hub an important proxy as a hedging tool against natural gas price risk.
Japan: Japan has accelerated its domestic market liberalization reform program, enabling the full liberalization of its downstream market as of 2017, the establishment of a Gas Market Surveillance Commission as a regulatory body, and the introduction of transportation unbundling, which is to be fully active by 2022.
Korea: As per the Urban Gas Business Act, large scale consumers are allowed to import natural gas for their use. In 2017, the number of importers doubled from four to eight.
Singapore: Singapore has unbundled natural gas transportation and competitive activities, with imports being granted through licenses.
China: CNOOC, which is the biggest operator of LNG import terminals in China, is opening up its LNG import infrastructure to third party consortiums.
Scope
Near term: With the upcoming elections in the US, uncertainty in terms of government policies are significant and may likely result in higher volumes for henry hub futures.
Long term: The volatility in demand for natural gas is majorly caused by changing weather patterns, so futures are an essential tool to hedge against this risk.
There is no clear evidence regarding the increase in tropical cyclones in the US. The US temperature has substantially risen over the past 30 years, resulting in warmer winter months, which can affect the demand side of natural gas.
Conclusion
Global markets are also recognizing the monetary benefits of using natural gas as a hedging tool. Market liberalization, pragmatic pricing, and robust liquidity made Henry Hub futures the top choice for the market participants throughout the Globe.
Contributor: Vineet Agarwal
Research Desk | Leveraged Growth
I am a motivated student currently working towards an undergraduate degree in Mechanical Engineering from BITS Pilani. I am also a candidate for FRM part-2. I am passionate about finance and interested in risk management. I like to play badminton, read books, and learn guitar in my free time.
