What it means
A hub is a physical meeting point where gas from many pipelines can be bought, sold and moved between different routes. Henry Hub, located near Erath in Louisiana, connects to a network of pipelines serving producers and consumers across the country.
Because it is liquid, meaning there are always many buyers and sellers, its price is seen as a fair reflection of supply and demand. Natural gas is priced in dollars per MMBtu, a million British thermal units, which is a measure of energy content.
The futures contract traded on the New York Mercantile Exchange specifies delivery at Henry Hub and covers 10,000 MMBtu. Traders, producers, utilities and manufacturers use these futures to lock in prices and manage risk.
Few buyers actually take delivery at Henry Hub, so most contracts are priced off it with an adjustment called the basis. The basis is the difference between the local price of gas at a particular place and the Henry Hub price, and it reflects transport costs and local supply and demand.
A power plant far from the producing regions will typically pay Henry Hub plus a positive basis, while a producer in an oversupplied area may receive Henry Hub minus a discount. The price moves with weather, storage levels, production, the cost of competing fuels and exports of liquefied natural gas.
A cold winter raises heating demand and can push prices up, while a surge in drilling can push them down. Finance teams in energy-intensive businesses watch it closely because gas can be a major cost of producing chemicals, fertiliser, glass and electricity.
Henry Hub is a North American benchmark, so it does not set prices everywhere. Europe and Asia have their own gas benchmarks, which can differ widely from it because of shipping costs and regional demand.
Contracts that are linked to oil prices rather than to a hub also still exist in some markets. Companies that use gas in large volumes usually manage the risk in layers.
They might fix the price on part of their expected use with futures, buy part at the monthly average and leave the rest to the spot market, so that no single price move can wreck the budget. The finance team then reports the hedged share and the remaining exposure to the board.
In practice
Real-world examples.
Example
A chemical manufacturer buys gas under a contract priced at Henry Hub plus $0.30. Its CFO uses futures to fix the hub price for the next 12 months, which makes its main raw material cost predictable.
Example
A gas producer in the northeast sells its output at a discount to Henry Hub because pipeline capacity is limited. The finance team forecasts revenue by taking the benchmark and subtracting the typical basis.
Example
A power company hedges (protects against) a rise in gas prices before winter by buying futures. If prices climb, gains on the futures offset the higher cost of fuel for its generators.
Formula
Calculation
Delivered gas cost = volume in MMBtu x (Henry Hub price + basis)
Suppose a fertiliser plant buys 50,000 MMBtu of gas in a month. The Henry Hub price for the month is $3.00 per MMBtu and the local basis is +$0.40.
Step 1: Delivered price = 3.00 + 0.40 = $3.40 per MMBtu.
Step 2: Monthly cost = 50,000 x 3.40 = $170,000.
If Henry Hub rises by $0.50 to $3.50, the new price is $3.90 and the monthly cost becomes 50,000 x 3.90 = $195,000. The increase is $25,000 a month, which is 50,000 x 0.50, so the plant's cost is highly sensitive to the benchmark.Case study
Seen in the real world.
Greenfield Glassworks is a fictional manufacturer that uses 600,000 MMBtu of gas a year. When the Henry Hub price rose from $2.50 to $4.00 in a single year, its fuel bill increased by 600,000 x 1.50 = $900,000, which took a large bite out of its profits.
In this illustrative story, the CFO started a hedging programme the next year. She bought futures to cover two thirds of expected use at about $3.50 and kept the rest open. Prices rose again, but the hedge limited the damage, and the board began to treat gas price risk as a standard item in the budget.
Watch out
Common mistakes.
- Assuming that the Henry Hub price is the price everyone pays, when local basis, transport and contract terms can change it significantly.
- Confusing the spot price, which is for immediate delivery, with the futures price, which is for a future month.
- Using it as a benchmark for gas outside North America, where regional prices follow different drivers.
Questions
People also ask.
Where is Henry Hub?
It is in Louisiana, in the United States, where a number of pipelines connect near the Gulf Coast.
What is an MMBtu?
It is a million British thermal units, a standard measure of the energy content of natural gas.
What is basis?
It is the difference between the local price of gas and the Henry Hub price, and it reflects transport costs and local supply and demand.
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