The volume of US natural gas traded during bidweek is poised for its fourth straight year-on-year decline as banks and other large players pull back from the monthly baseload market, according to a Platts examination of IntercontinentalExchange data.
"If there is no real money flow or nobody wants to put capital to work, the market retrenches and atrophies when the physical market is the primary market," said one Gulf Coast trader. "Banks are not too enamored about putting money into the market where the returns are pretty small."
For the first five months of 2014, including physical deals for delivery in May, bidweek volumes are down 27.5% to 38 million MMBtu compared with the same period last year, when 52.4 million MMBtu traded between January and May.
So far bidweek volumes in 2014 have averaged 7.59 million MMBtu each month. If that average were to continue, the total traded volume during bidweek for 2014 is estimated to only reach 91.1 million MMBtu, down from 118.3 million in 2013, or 23%.
The year-to-year drop shows a significantly less liquid trading environment compared with 2012, when 150.3 million MMBtu traded and 2011 when volumes reached 145.3 million MMBtu.
The years 2011 and 2012 saw monthly bidweek volumes average 12.2 million MMBtu and 12.5 million MMBtu, respectively. But since January 2013, bidweek volumes have only averaged above 10 million MMBtu on five occasions, the last of which was August 2013.
Since then, bidweek volumes have averaged 7.9 million MMBtu, according to ICE data.
According to the most recent bidweek data released by ICE on Friday, declines were pronounced as May bidweek volume saw a 41% decline compared to the same time last year.
The trend has been brought on primarily by the declining profitability of intermediation and the subsequent departure of the investment banks from gas and power trading.
"When we think about intermediation you think about banks," said Teri Viswanath, director of natural gas strategy at BNP Paribas. "The traditional way to trade and make money, which is to buy gas out of a traditional production region and shipping to Chicago or New York markets... those deals don't have the same value propositions as they once did a decade ago."
GULF COAST ACTIVITY SLOWS
For example, the average bidweek volumes at NGPL-TXOK East Pool in Texas fell in 2013 by 48% from 2012 levels. So far, 2014 bidweek volumes at that location are off a further 60% from 2013 levels, averaging just 148,526 MMBtu per month.
Furthermore, the number of counterparties at the location is also trending lower. In 2011 and 2012, the location had averaged 24 to 25 counterparties per month, according to ICE data. But since then, that has fallen to average 15.5 in 2013 and 12.2 in 2014 per month.
"If you look at the Gulf Coast, the offshore, Haynesville Shale... the basis has reflected the changes, but as far as traditional Gulf Coast southern production areas, the low levels of volatility are barely keeping people in business here," said one bidweek trader who was not authorized to speak for attribution.
Consequently, the trader said that due to in part to new regional supplies such as the Marcellus Shale, Gulf Coast trading "gets a little too thin, a little too illiquid and it gets pretty tough in the long term."
But while low volatility has led to bidweek volume declines in the Gulf Coast market, in the historically more volatile Northeast depressed bidweek volumes have led to larger bid-offer spreads and greater price volatility.
"You have fewer banks and a lot fewer physical shops making markets. ... You also have a lot more momentum players in here just creating wild swings," the trader said.
Over the winter, which saw wild price swings in some locations, not only did fewer participants lead to more volatility but pipeline inefficiencies also played a role.
This left the Northeast with a combination of factors that caused market participants and regulators to question whether excessive speculation or "other market abuses" were at play, as the American Public Gas Association said in late February when it called for a federal investigation into NYMEX gas futures trading during February contract expiration.
In such locations as Dominion South and the Algonquin city-gates, high prices and low volumes were consistent during February's bidweek, even when demand for gas reached some of the highest levels in decades.
Dominion South saw prices rise in February to $6.157/MMBtu, with only 179,280 MMBtu traded. That compares with relatively milder winters when 582,019 MMBtu was traded in February 2013 and 754,010 MMBtu in February 2012.
Meanwhile, Algonquin city-gates saw prices skyrocket on light volume to $39.557/MMBtu in February 2014 on only 91,000 MMBtu. That is down from 230,835 MMBtu during February 2013 bidweek and 216,600 MMBtu in 2012, according to ICE data. Then, prices averaged $9.145/MMBtu and $4.997/MMBtu, respectively.
Low volume and prices spikes are signals of a less than liquid market. But even when intermediation would presumably be more profitable like in the Northeast this past winter, the simple economics of year-round natural gas trading in the US has driven banks away from the business and has intensified the volume declines.
The reason for such departure is fairly straightforward: publicly traded banks such as JP Morgan, Deutsche Bank and Morgan Stanley, which have all announced retreats from physical energy trading, are judged on two important factors each quarter: risk-weighted-assets and return on equity.
As leadership at the banks review at their energy portfolio they have seen both of those categories lagging. Energy trading, and specifically physical energy trading, is expensive, so when profitability wanes it comes as no surprise trading desks are shut -- especially when banks are pressured to use every dollar as efficiently as possible.
However, there is the outside possibility that the global merchant trading groups could fill the gap.
Citing increased regulatory scrutiny and lower profitability, one of the largest US gas marketers, JPMorgan Chase, recently initiated the sale of its physical energy business to Geneva-based Mercuria Energy Trading for $3.5 billion.
"There are also some hedge funds that are trying to fill the gap, but they don't have a real physical presence. I think financially, Mercuria can fill the gap," one bidweek trader said.
Furthermore, CEO Ian Taylor at oil-trader Vitol, which reported 2013 revenues of $307 billion, said his company sees opportunities where the banks have not.
"The withdrawal of some investment banks from commodity-related actives has reduced liquidity in markets such as power, but created longer term opportunities and our footprint in both the US and Europe is growing," Taylor said.
Firms such as Vitol, Trafigura and Mercuria because of their singular focus on energy trading can operate with much larger balance sheets and can withstand less profitable market-making compared to the more diverse banks.
But so far "we haven't seen the hand-off," Viswanath said, so as no new players have entered the market given the regionalization of gas supplies and nascent volatility; it looks as though volumes could remain low for the foreseeable future.
