Knowledge Base

Natural Gas Segmentation

Natural gas pipelines, whether contained within a single state (intrastate) or crossing state lines (interstate), connect markets. This ability to span markets gives pipeline capacity its value as holders of the capacity can move gas from low-price locations to high-price locations. Often, as we've seen, this is done to meet the shipper's own operational needs but other times it's done purely for profit.

Holders of capacity spanning multiple locations often consider the capacity as separate segments, referred to "pipeline segmentation". Each segment (or really any subset of the full path) of the pipeline which connects two markets can be viewed as a physical spread between the two locations which can be "optimized" against the financial market spreads between the two locations.

For example, assume a company holds 10,000 MMBtu of capacity on a pipeline from location A to location C. They view the capacity as comprised of two segments: A to B and B to C. The commodity charge incurred on each section is equal to $0.35 (we will ignore losses for simplicity). If the price difference between locations A and B are less than the cost to transport gas from A to B, then the segment is considered non-economic in that to utilize the transport would be to lose money. For example, if the price at location A is $2.30 and the price at location B is $2.60, then the profit to be made by moving gas from A to B would be $0.30. However, the cost would be $0.35 (it would be higher still if we factored in losses as the $0.35 would need to be "grossed up"). If the price at location C is $3.60, then the profit to be made by moving gas from B to C would be $0.40 against a cost of $0.35. In this case, using the B to C segment will generate a profit while using the A to B segment would result in a loss. In reality, the problem is even more complex as the losses and commodity charges from A to B and B to C are separate and distinct from the losses and commodity charges from A to C (to say nothing of backhauling (e.g. C to A, B to A, etc.)).

This evaluation of market prices against transport costs is considered every day by thousands of companies holding capacity rights on natural gas pipelines. Each segment is evaluated to determine whether its value exceeds the costs of utilization. And each day, as market conditions change and prices move, the analysis is evaluated over and over again.

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