Summary — Market Supply and Market Demand

Overview: Two Dimensions of the Natural Gas Industry

The natural gas industry operates across two distinct but interdependent dimensions. The first is the physical operational side — the people in the field who make gas flow every day through pipelines, compressor stations, processing plants, and storage facilities. The second is the commercial/business side — the people in offices who negotiate agreements, arrange logistics, schedule gas movements, and manage customer relationships.

This module focuses primarily on the commercial side, specifically the role of a marketing company (also called a marketer or marketing firm). Understanding both dimensions is essential because the commercial parties depend entirely on the physical operators to fulfill their contractual obligations.

The Role of a Marketing Company

A marketing company sits at the center of the natural gas value chain. It does not typically produce gas or own pipeline infrastructure — instead, it acquires gas (supply) and disposes of gas (sales) while coordinating all the logistics in between.

To operate legally and effectively, a marketing company must have the following agreements in place:

• Purchase agreement with a producer or another marketer (to acquire gas)
• Transportation service agreement with a pipeline (to move the gas)
• Processing agreement with a processing plant (to clean/condition the gas)
• Storage agreement with a storage facility (to hold gas for later use)
• Sales agreement with customers (to sell the gas)

The purchase and sales agreements are called commodity agreements because they involve buying and selling the physical commodity. Transportation, processing, and storage agreements are called service agreements because the counterparties are providing a service rather than delivering a commodity.

Three Ways to Acquire Gas (Supply)

A marketer can bring gas into the flow in three ways:

1. Purchase gas from a producer or another trading company via a commodity agreement. This is the most common method.
2. Withdraw from storage — gas that was previously injected into a storage facility can be withdrawn when needed. A special variant is parking and loaning (P&L), where a storage operator allows a marketer to borrow gas it has not personally injected, in exchange for returning it later (plus a fee).
3. Resolve imbalances — when a marketer inadvertently leaves gas in a pipeline (goes long) or comes up short (goes short), that over- or under-delivery creates an imbalance. The marketer can later schedule delivery or receipt of that gas to balance the account. The original imbalance is unintentional; the resolution is a planned event.

Three Ways to Dispose of Gas (Disposition)

Once gas is acquired, a marketer must dispose of it in one of the following ways:

1. Sell it to a customer via a sales agreement. Once sold, the gas no longer belongs to the marketer — this is the ultimate destination.
2. Retain fuel — pipeline compressor stations consume a percentage of a marketer's gas as fuel to push gas through the system under pressure. This is called pipeline fuel. Similarly, processing plants consume some gas to run their equipment — this is called plant fuel. Both are deducted from what the marketer originally put into the system.
3. Inject into storage — if a marketer buys more gas than it currently needs to deliver, it can inject the excess into storage as a temporary holding point, to be withdrawn later.
4. Imbalance — an unintentional over-delivery (being long) leaves gas in the pipeline, which counts as a temporary form of disposition until resolved.

Contract Fundamentals: Why Contracts Matter

A foundational rule of business is: never conduct business without a contract. In the natural gas industry, every relationship — with producers, pipelines, storage operators, processing plants, and customers — must be formalized through a written agreement before any gas flows or services are rendered. Contracts establish expectations, define quantities, set pricing, specify timing, and provide legal remedies for non-performance.

Two Fundamental Contract Types: Firm vs. Non-Firm

Regardless of the many names used in the industry (spot, swing, interruptible, base load, etc.), all contracts ultimately fall into one of two categories:

Non-Firm Agreements

• Generally shorter term in nature; offer greater flexibility
• Delivery is on a best efforts basis — the counterparty tries but cannot guarantee performance
• Subject to being cut or zeroed out (i.e., non-delivery)
• No legal recourse available for non-performance because performance was never guaranteed
• Common names: spot, swing, interruptible

Firm Agreements

• Generally longer term in nature; used for base load supply or service
• Delivery is guaranteed except in cases of force majeure (act of God — e.g., hurricane, tornado destroying infrastructure)
• Highest performance priority — firm customers are served before interruptible/non-firm customers
• Legal recourse available for non-performance
• Non-performance is resolved through make-whole (keep-whole) provisions

Analogy: Think of a firm agreement like buying season tickets to a sports team. You pay whether you attend games or not, but your seat is guaranteed. A non-firm agreement is like hoping a friend will pick you up at the airport — they'll try, but if they don't show, you have no recourse.

History of Industry Contracts: From Legacy to Standardization

Legacy (Proprietary) Contracts — Pre-1996

• Every deal had a unique, custom-written contract — different terms, different language, different interpretations
• Required large legal teams; created enormous overhead
• Disputes over contract language were common, often leading to litigation
• The instructor recounts regularly testifying in court cases arising from contract interpretation disagreements

GISB — Gas Industry Standards Board (1996)

• The industry collectively decided to create one standardized contract template — fill in the blanks with counterparty names, quantities, prices, and dates
• Language was identical across all contracts; specifics were filled in as variables
• Dual-purpose design: one contract governed both buying and selling between two parties, eliminating the need for separate purchase and sale agreements
• Significant reduction in legal costs and disputes
• Some GISB contracts still exist today (legacy agreements from the mid-1990s through early 2000s)

NAESB — North American Energy Standards Board (2002)

• Other energy industries (oil, coal, electricity, liquids) adopted and expanded the GISB model
• NAESB replaced GISB and extended standardization across all energy commodities
• Still the prevailing standard contract framework today
• Key features added: dual-purpose buy/sell agreements, keep-whole (make-whole) non-performance resolution, and net invoicing

Keep-Whole (Make-Whole) Provision — Explained with a Numerical Example

Under a firm NAESB agreement, if a counterparty fails to deliver contracted volumes, the injured party is kept whole — meaning the non-performing party must cover any financial loss the injured party incurs by having to source replacement gas at market prices.

Example from the lecture:

• A marketer buys 10,000 units at $2.00/unit (transaction date: February, flow date: November)
• Expected purchase cost: $20,000
• Expected sales price: $2.10/unit → Sales revenue: $21,000
• Expected profit: $1,000

When November arrives, the supplier delivers only 7,000 units instead of 10,000. The marketer must go into the open market to buy the missing 3,000 units at the current market price of $3.00/unit.

• Replacement cost: 3,000 × $3.00 = $9,000
• Total gas cost: $14,000 (original 7,000 × $2) + $9,000 = $23,000
• Net result without keep-whole: Loss of $2,000 instead of a $1,000 profit

Keep-Whole calculation: The marketer invoices the supplier as if they had delivered all 10,000 units at $2.00 ($20,000), then deducts the extra $1.00/unit premium paid on the 3,000 replacement units ($3,000). The supplier receives $17,000 instead of $20,000 — effectively paying back the $3,000 price differential that the marketer was forced to absorb. This restores the marketer's profit to approximately $1,000.

Key rule: Keep-whole provisions apply only to firm agreements. Non-firm agreements carry no such remedy — best-effort performance means no guarantee and no penalty.

Analogy: You book 10 airline tickets for a club trip at $500 each. The travel agent can only produce 7 tickets on the day of travel, and the remaining 3 now cost $800 each. The travel agent is responsible for compensating the $300/ticket difference because they failed to perform on a firm commitment.

Net Invoicing (NAESB Settlement Feature)

Before NAESB, when two companies traded with each other and also owed each other money from simultaneous buy/sell transactions, each would transfer the full gross amount through their banks — resulting in hundreds of millions of dollars flowing in both directions, with banks collecting fees on the full amounts.

Under the NAESB net invoicing (also called invoice netting) feature:

• The two obligations are offset against each other
• Only the net difference is transferred between the parties
• Example: Company A owes Company B $100,000,000. Company B owes Company A $100,000,100. Under net invoicing, Company B simply sends Company A $100 — the net difference.
• Banks process vastly smaller transaction amounts, reducing transaction costs and administrative burden significantly

Demand Charges vs. Commodity Charges

Understanding the distinction between these two charge types is critical for any ETRM professional.

Firm Demand Charge

• A fixed charge paid for the right to capacity, regardless of whether that capacity is actually used
• Analogous to season tickets: you pay whether you attend the game or not
• What you receive in return: a guaranteed slice of pipeline (or storage, or processing) capacity reserved exclusively for you
• If you pay a firm demand charge on a pipeline, the pipeline holds your contracted volume for you — if non-firm shippers are using that capacity and you show up, they get bumped off
• Formula: Demand Charge = (Reserved Quantity) × (Demand Rate per Unit)
• Example: 50,000 units/day reserved at $1.00/unit demand rate = $50,000/month fixed charge, paid whether you move gas or not

Commodity Charge

• A variable (activity-based) charge — you pay only when you actually use the service or move/buy/sell gas
• If no gas moves, no commodity charge is owed
• Formula: Commodity Charge = (Actual Quantity Moved) × (Commodity Rate per Unit)
• Example: 15,000 units moved × $0.035/unit = $525

Relationship Between Demand and Commodity Rates

Shippers who pay a firm demand charge are rewarded with lower commodity rates because they are already compensating the pipeline for holding capacity. Interruptible (non-firm) shippers pay higher commodity rates because they pay no demand charge.

Business implication: If a marketer has firm sales customers who need guaranteed delivery, it must secure firm transportation. Using interruptible transport runs the risk of being bumped by firm shippers, causing a failure to deliver to customers — which damages business relationships.

Swing Provision (Hybrid)

A swing provision negotiated within a firm agreement allows the marketer to take additional gas (above the base load quantity) on a best-efforts basis, often at a discounted rate. The swing volumes do not carry the same delivery guarantee as the base load — they are best effort within the firm contract structure.

Fee and Tax Charges

Marketing/Broker Fees

Fees paid to a broker, consultant, or third-party marketer who provides services such as locating supply, arranging transport in an unfamiliar region, or negotiating deals. These are negotiated service fees on top of demand and commodity charges.

State Taxes — production tax." class="glossary-term">First Purchaser Tax

In producing states like Texas, the state levies a first purchaser tax (also called a production tax). The first company that buys gas from a producer must collect this tax on behalf of the state — similar to how a retailer like Walmart collects sales tax on behalf of the state at the point of sale.

Carriage Tax

For states that do not produce natural gas but that gas pipelines pass through (called box states or pass-through states), these states levy a carriage tax — a fee for the gas transiting through their territory. Named historically after horse-drawn carriages, this tax compensates the state for allowing energy to flow across its borders.

Commodity Pricing Mechanisms

There are several distinct ways to price a gas transaction:

Flat / Fixed / Stated Price

A straightforward, negotiated price agreed to by both parties at the time of the deal. Terms like "flat," "fixed," and "stated" all mean the same thing — the price does not change based on market movements.

• Example: "I'll buy 10,000 units at $2.00." Done.

NGX) that survey market participants. Represents the consensus market value of gas at that location." class="glossary-term">Index Price

The index price is an average market price at a known, actively traded location (called a liquid point or liquid hub). Companies like Platts and NGX survey traders and companies to determine what the average price of gas is at major hubs on a given day.

• Example: Henry Hub, Katy Hub, Chicago City Gate are all well-known liquid pricing hubs
• A liquid point has enough buyers and sellers that a reliable average price can be established
• A non-liquid point lacks sufficient trading activity to establish a reliable independent price

Index Plus / Minus (Premium or Discount)

A price expressed as the index price adjusted up or down:

• Index + Premium: Seller wants more than the index (e.g., during cold weather when demand spikes)
• Index − Discount: Seller offers less than index (e.g., during warm weather when demand is weak and the seller needs to move gas)

Basket Price (Calculated/Formula Price)

A basket price is a formula-based price built from multiple components — like a grocery basket with different items. It is used when purchasing gas at a non-liquid point (a location without its own index) by referencing a nearby liquid index and adjusting for the costs of moving the gas between locations.

Formula structure:

Basket Price = Nearby Index Price − Transport Cost − Fuel Cost − Administrative/Other Fees

Example from the lecture:

• Katy Hub Index: $2.10/unit
• Purchasing gas at a remote non-liquid point
• Transport cost from that point to Katy: $0.09/unit
• Fuel cost: $0.12/unit
• Administrative inconvenience fee: $0.035/unit
• Basket (Offer) Price: $1.865/unit

The logic: "Why should I pay Katy index AND pay to move the gas to Katy? I'll pay you what it's worth at your location — Katy price minus what it costs me to get it there."

Reverse direction (gas closer to market than Katy): If the non-liquid point is between the production area and the market, the seller has already incurred transport costs getting it closer to market — so the buyer would pay more than the base index, compensating the seller for those incurred costs.

Landed Price: The Most Important Pricing Concept

Landed price is the total all-in cost of gas delivered to the buyer's point of use — the purchase price plus all logistical costs (transport, fuel, processing, fees) to get it there. This is the true cost of gas and is the correct basis for comparing supply options.

Why purchase price alone is misleading:

Despite Oklahoma gas being $0.275/unit cheaper to purchase, Louisiana gas has a $0.105/unit lower landed price because of significantly lower transport costs. A marketer choosing based on purchase price alone would make the wrong decision.

Analogy: A $100 item with $30 shipping costs more at the door than a $125 item with free shipping. You don't know the true cost until you calculate landed price.

Market Participants and Their Business Objectives

Important distinction for marketers: A high gas price market does not automatically mean higher profits for a marketer. If a marketer buys at $7.55 and can only sell at $7.45, it loses money — even though the market is "high." Conversely, buying at $2.00 and selling at $2.25 in a low-price market yields a solid margin. The margin, not the absolute price, drives marketer profitability.

Exception — storage arbitrage: When a marketer buys gas in a low-price season (summer, at e.g., $2.50), injects it into storage, and withdraws/sells it during a high-demand period (winter cold snap, at e.g., $10.00+), the timing differential creates exceptional profitability. This is the primary way marketers generate large profits beyond normal buy-sell margin.

ETRM Technology and Source Information

Importance of Source/Reference Data

In any ETRM (Energy Trading & Risk Management) system, the quality of source (reference) data determines the accuracy of everything downstream: nominations, scheduling, invoicing, accounting, and risk management. The instructor emphasizes that 60–70% of a successful ETRM implementation depends on accurate source data.

Errors in source data cascade throughout the system:

• Wrong contract number → incorrect invoice
• Wrong point name → failed nomination
• Misspelled counterparty name → pipeline rejects scheduling data

EnergyFlow System (Course Lab Tool)

The course uses EnergyFlow as its ETRM platform. Lab exercises require students to set up source information in the following order:

1. Legal Entities — Add all counterparties (pipelines, producers, customers, etc.) with correct names, short names, addresses
2. Contracts — For each legal entity, add the appropriate agreements:
   • Pipelines: Pipeline contracts, service contracts, locations
   • Trading partners: Trading agreements
3. Accounts — Chart of accounts entries (assets, liabilities, equity, expense accounts like "Purchase Gas Cost 501")
4. Account Links — Map transaction types to the appropriate debit/credit accounting entries

A student portal within EnergyFlow provides real-time validation — green checkmarks indicate correct entries; red flags identify specific errors (misspellings, missing data).

ICE (Intercontinental Exchange)

Trades entered by traders on the ICE platform flow electronically into the company's Oracle database and appear in the ETRM system in near-real time (within seconds of the trader hitting save). A watchdog program monitors the connection with a heartbeat signal and automatically reconnects if the link drops, ensuring traders never experience data loss.

Price Components and Business Calculations Summary