Houston Ship Channel, one of the most vibrant spot gas markets in Texas and a benchmark for prices across the state, has confounded traders, end-users and market analysts over the past 18 months because of unexpectedly low prices and a sudden divergence of physical and financial markets.
"ETC was always involved, according to the brokers. I talked to more than one buyer who told me it was ETC," - a trader.
A Platts analysis of the last two and a half years of published monthly index prices, published daily assessments of the financial basis-swap market, and closing prices for the NYMEX Henry Hub contract shows that large disconnects appeared in late August 2005 and continued through the closing days of October in trading for November 2005.
The most striking example occurred when the Ship Channel price for October 2005 fell dramatically below the NYMEX futures contract price and the physical and financial markets at Ship Channel suddenly disconnected.
Monthly indexes for physical gas at Ship Channel, generally no more than about 50 cents below the NYMEX contract, tumbled nearly $3.50/MMBtu below the NYMEX settlement for October 2005.
The financial basis-swap market, used for hedging speculative trading, often trades within a dime of monthly physical prices.
And the physical-financial monthly settle, which determines gains and losses of buyers and sellers in the large financial basis-swap market, rarely differs by more than 40 cents.
But the discount between the monthly benchmarks for the two markets ballooned when the physical market fell $2.04/MMBtu below the financial market for October 2005 and $1.12/MMBtu below for November 2005, the analysis shows.
Differing - but not mutually exclusive - explanations for the unusual pricing dynamics emerged from interviews with traders, consultants and regulators involved in the Ship Channel market and other analysts with general expertise in gas markets.
Reasons offered included hurricane-related supply disruptions, demand destruction among industrial end-users and increasing production from the Barnett Shale fields.
But according to two traders active in the Ship Channel market, who spoke on the condition of anonymity because they are not authorized by their companies to discuss gas markets with journalists, there was another dynamic behind the lower monthly prices at Ship Channel: Energy Transfer Co., a large intrastate pipeline with a strong market presence at Ship Channel, drove physical prices lower there in what appeared to be an aggressive pursuit of a commonly used trading strategy - arbitraging the difference between prices in the physical and financial markets.
The two traders work at different companies and provided independent accounts of trading activity they observed at Ship Channel.
When asked to comment on its trading activity at Ship Channel, ETC said in an e-mail: "Our activities during and after the hurricanes of late 2005 were critical in delivering gas to customers in the affected regions.
We are aware of a government inquiry into the unprecedented natural gas market disruptions during the hurricanes, and we have provided information concerning transactions during this period.
Our trading activities have been, and continue to be, in compliance with all applicable laws and in the interest of providing our customers with reliable service."
Arbitrage between physical and financial markets is a longtime, legal and widespread practice. It allows market participants to manage their risk by limiting how much they would profit or lose when the price of physical gas differs from their expectations.
Further, it offers an opportunity to trade speculatively and increase profits by betting correctly on relative price movements between physical and financial markets.
Financial basis swaps for month-ahead gas settle on the difference between the two markets: If the index for the physical market settles below the financial market price specified in the swap, the seller collects the difference.
At Ship Channel, from late 2004 through early 2006, the two traders said a seller in the monthly market would swoop in on the IntercontinentalExchange trading platform on the third day of the five-day physical bidweek trading period - the day the NYMEX contract expires - and offer physical gas for the following month at prices well below earlier deals that day and the previous two days.
The two traders said brokers and buyers who were on the other side of the lower-priced deals told them repeatedly that the seller was ETC.
"Everybody in the industry knows it was them," said one of the traders. "I have that knowledge from watching the market and from conversations. Everybody talked about ETC and the Ship Channel index. It's common knowledge."
"ETC was always involved, according to the brokers. I talked to more than one buyer who told me it was ETC," the trader said, adding that he also had conversations with ETC about the fact that that it was the seller in the lower-priced deals.
The second trader similarly said he had heard from brokers that ETC also was the "big seller" in the financial basis market, in addition to being the one selling physical gas below the market.
According to the two traders, the unusually low-priced trades, which came to an end early this year, strongly suggested a strategy of pushing monthly physical indexes down to increase profits on large financial positions taken up to that point - in effect, big bets that the monthly physical gas index would settle lower than expected by trading counterparties in the swap market and create a larger than expected gap between the two markets to increase the profit on every swap ETC sold.
By selling physical month-ahead gas at lower prices, the traders said, such a strategy would involve taking a relative loss - or less of a gain - on physical deals because a low monthly index price for physical gas would mean more robust profits on a much larger short position in the financial swap market.
ETC's large pipeline holdings in southeast Texas, expanded through a series of acquisitions, gave it access to gas at Waha, the growing production from Barnett Shale of north Texas and other production areas and the ability to move it to Ship Channel.
That access to production and extensive pipeline systems, combined with a merchant trading operation, gave it the tools to carry out such a strategy in the lightly regulated Texas intrastate pipeline and gas market, the two traders and others interviewed said.
In addition to ETC, other important players at Ship
Channel and in the surrounding southeast Texas market
include two other major pipelines - Kinder Morgan, and
Enterprise Products Partners - and a number of major
producers, such as BP, ConocoPhillips, Shell, Chevron and
Total.
Companies seen regularly in the trading market at Ship
Channel, according to sources, include ETC, BP,
ConocoPhillips, Chevron, Shell, through its Coral Energy
unit, Sempra Energy Trading, Merrill Lynch Global
Commodities, Louis Dreyfus Energy Services and Total.
Created: September 26, 2006
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