What is a hub
Geographical location where multiple participants trade energy. Several characteristics define a gas hub. In essence a hub facilitates gas wholesale trading as a marketplace and defines a hub gas price market. The network operation, availability of ample gas supplies and liquidity of products (short and medium term), and the legal framework are central to the hub design. According to the IEA:
“For the creation of a gas hub, the legal and regulatory framework for the gas market is essential together with the facilitation of the wholesale trading rules and procedures. Creation of a gas hub requires an independent and neutral player, a network operator to facilitate the market place for all market participants to book, allocate and transport capacity along the gas network. The network operator needs to be unbundled so it can guarantee independent management and access for market participants. This also requires transparent third-party access and transparent rules for capacity allocation, congestion management and balancing. The regulator and the competition authority have to play a strong role to promote competitive suppliers, sufficient network capacity and flexible trading products.
US Hub
Natural gas is priced and traded at different locations throughout the US. These locations, referred to as market hubs exist across the country and are located at the intersection of major pipeline systems. There are over 30 major market hubs in the U.S., the principle one of which is known as the Henry Hub, located in Louisiana. The futures contracts that are traded on the NYMEX are Henry Hub contracts, meaning they reflect the price of natural gas for physical delivery at this hub. The price at which natural gas trades differs across the major hubs, depending on the supply and demand for natural gas at that particular point. The difference between the Henry Hub price and another hub is called the location differential.
TTF and NBP still dominate European Hub Trade
The UK gas hub is the NBP. In North West Europe there are several gas hubs, such as Zeebrugge in Belgium, TTF in Holland, NCG in Germany, PEGs in France and others. In 2016, the TTF was continental Europe’s chief benchmark pricing hub overtaking NBP. The TTF and NBP remain Europe’s risk management hubs, as they are the only ones with substantial trade in contracts beyond month-ahead or options trading.
A similar pattern emerges in the churn ratio, which measures how often a gas molecule is traded. The OIES considers a hub mature when total traded volumes are at least 10 times greater than physically traded volumes - parameters met only by the TTF and NBP. The OIES reckons Europe’s hubs provide a reliable pricing reference.
LNG-based hubs
LNG-based hubs present a number of challenges compared to pipeline-based hubs.
Pipeline hubs rely on more or less continuous flows of natural gas, daily scheduling of receipts and deliveries, homogeneity of product, standardized natural gas specifications, uniform transportation and contracting rules, and diligent regulatory oversight.
In contrast, LNG price discovery presents a number of challenges to the pipeline based model of market hub and price index development. LNG shipments can be large and difficult to store, there can be significant time between contracting and delivery, and cargoes can differ in LNG specifications. An LNG market hub needs to also include port facilities, LNG storage, regasification or liquefaction capacity and pipelines interconnected with the markets. As the global LNG market continues to evolve and mature, reliable pricing indexes and market hubs in Asian countries will fundamentally transform the global LNG market into a more efficient, integrated, and transparent market.
Asian markets
Asian markets lack a transparent pricing benchmark. Although Asia is the major global LNG trader, the region lacks a liquid and transparent LNG pricing benchmark similar to the Henry Hub in the United States or the NBP or TTF in Europe.
The large Asian markets (Japan, South Korea, Taiwan, China and India) have traditionally relied on LNG, which has been priced under long-term contracts tied to crude oil prices. With significant expansion of the global liquefaction capacity and changes to LNG contracting, a more market-sensitive trade in LNG is emerging. However, Asia does not have a fully functioning pricing point that can reliably transmit price signals to the market. Development of reliable pricing indexes and market hubs in Asian countries that reflect the underlying demand-supply fundamentals becomes increasingly important as global natural gas markets evolve and mature.
Multiple initiatives are underway to facilitate price discovery in Asian LNG markets. Japan, China, and Singapore are now developing regional trading hubs in Asia Pacific markets and have launched LNG pricing indexes to increase the transparency in price formation.
The formation of functional natural gas market hubs in Asia Pacific will take time. In the United States and Europe, the development of natural gas hubs and pricing indexes took 15 years and 10 years, respectively. Each of the proposed LNG market hubs in Japan, China, and Singapore faces considerable regulatory and infrastructure challenges, including lack of third-party access to infrastructure and limited pipeline connectivity within and between countries. To attract multiple participants and reduce possible dominance of large, incumbent players, market liberalization will be necessary, including a regulatory environment that assures equal third-party access to natural gas infrastructure (pipelines, regasification facilities, storage, etc.) and promotes transparent LNG pricing based on demand and supply fundamentals.
The key 5 elements needed for a hub (According to OEIS):
Fully mature gas market hubs have many independent buyers and sellers, open access to transport facilities, trading liquidity, and clear and transparent price and volume reporting by price reporting entities (PREs). The reported prices can become indexes of market conditions at the hubs and attract non-physical traders who increase the market liquidity.
The evaluation of the maturity of the selected hubs is based on the evaluation of the following five key elements which will help in judging whether the criteria of depth, liquidity and transparency of these hubs are being met and to what degree. The 5 key elements are:
- Market participants: the number of active participants is an important indicator as to the development of a hub;
- Traded products: an important consideration when comparing traded markets to determine whether they are used for balancing or for risk management and so can produce a benchmark hub;
- Traded volumes: this element is associated with market activity and development and is a clear sign of a hub’s relative importance;
- Tradability index: in itself is not an indicator of depth liquidity and transparency.
- Churn rates: the multiple of traded volumes to actual physical throughout. The most important key element and a measure of a gas hub’s commercial success.
If the physical facilities necessary for a market hub are already present, a number of actions by government and industry are still required for gas market hubs that report reliable price formation to create real conditions for price discovery. These include adequate physical pipeline capacity for large volumes of gas with access to both supply and end use markets, nearby gas storage, adequate interconnection facilities, and a market hub operator.
The stages of gas market hub maturity are:
- Gas prices deregulated and gas sales unbundled from gas transmission – Governments deregulate the price of natural gas and regulators reform the market to separate the commodity sales function from transportation and other logistics services. Number of buyers and sellers increases
- Third party access to transport facilities, terminals – Regulators mandate that all potential infrastructure users have access on non-discriminatory commercial terms, known as third-party access. This opens the hub network to the new buyers and sellers.
- Bilateral trading predominates – Multiple parties begin to contract with each other on their own terms and over the TPA facilities. Producers can trade directly with distributors and large end users. The number of parties and transactions expand.
- Transparency in pricing and volume traded – Price reporting entities (PRE) begin publishing pricing information where prices and volumes are reported and published daily, weekly or monthly, under rules to ensure accuracy. Reliable price information supports bilateral trading and reduces transaction costs.
- Standardization of trading rules and contracts – Instituted by regulators or an industry organization, such as the North American Energy Standard Board (NAESB), ensures common use of terms and standardized trading and transfer practices. This facilitates trading by reducing transaction costs and making trading more efficient.
- Over-the-counter brokered trading – In addition to producers, distributors, and end users, traders such as merchants, financial institutions and brokers enter the market to trade gas and provide additional market liquidity.
- Price indexation – Liquidity at the hub increases to the point that PRE-reported prices at the hub become a reliable indicator of market balance. The reported prices become a reliable index that parties will cite for future pricing in long-term contracts.
- Non-physical traders enter – Non-physical traders offering pure financial hedging instruments based on the hub index enter the market to take price risk and offer customized OTC hedging services linked to the index.
- Future exchange – A commodity exchange such as the New York Mercantile Exchange (NYMEX) creates a standardized tradeable futures contract and offers a trading platform under exchange rules
- Liquid forward price curve – Parties trade large numbers of futures contracts for deliveries many months out, providing future price discovery and a means of managing price risk and future commitments
Israel has the aspiration of becoming an energy hub for the transfer of fuels that it wishes to purchase via the Turkish port of Ceyhan to the Israeli Mediterranean coast on to the Asian market from the Red Sea. For instance, Turkey’s objective is to become a regional energy hub. This means that Turkey wants to be both a transit state for gas, as well as a buyer and reseller of Caspian, Middle East, Russian and North African gas heading to European customers. For the EU there is no added value in buying Turkish gas when they can be buying Azeri and Turkmen gas directly from the producers.
