Kevin BassTrading ManagerBP Energy, NA Gas & Power

Physical Gas Trading

Agenda

• Natural Gas as Commodity – Characteristics

– Demand, Supply, and Transportation

• Natural Gas Market – Market Players

– Market Dynamics

• Natural Gas Pricing– Pricing (Monthly Index, NYMEX, Daily)

– Financial (support physical)• Swaps• Spreads

Natural Gas Characteristics

• It reduces America’s dependence on oil.

• Natural gas is the cleanest and most efficient fossil fuel.

• Natural gas is safe and reliable.

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2012

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Bcf/

d

• Demand is expected to continue to grow in all sectors, led by power generation

Natural Gas Demand Profile

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80

90

2000 2005 2010 2015

Gas

co

nsu

mp

tio

n (

bcf

/d)

Residential Commercial Industrial Electric Generation Other

64.6

Source: EIA, AEO 2003

67.6 74.381.1

U.S. Demand Outlook

Seasonality of Natural Gas Demand

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80

90

Billio

n C

ub

ic F

eet

Per

Day

Consumption

Net Imports

Domestic Production

Natural Gas Storage

• Injection – April thru October

• Withdrawals – November thru March

• Market area storage owned primarily by end use customers, and regulated by interstate pipeline tariffs.

• Production area storage, usually salt dome caverns, used for trading / market arbitrage.

US Natural gas Supply and Demand

40

50

60

70

80

90

BC

F/D

Consum ption

Production + Imports

Storage Withdrawals

Storage Injections Storage Injections

Storage Withdrawals

Storage Fields for Peak Demand

3,080

0

500

1,000

1,500

2,000

2,500

3,000

3,500

1 Jan

1 F

eb

1 M

ar

1 A

pr

1 M

ay

1 Ju

n

1 Ju

l

1 A

ug

1 S

ep

1 O

ct

1 N

ov

1 D

ec

Current Storage Level (2,944 Bcf)

2001

2002 2000

2003

Production Basin

Pipeline Capacity

Producing Basins & Regional Gas Flow

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35

1995 2000 2005 2010 2015

tcf/

yr

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60

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80

90

bcf/

d

Demand ~2% pa

Growth• Existing basins, i.e. Rockies and San Juan• Deepwater

Existing well supply

Growth• Alaska/Frontier• LNG • Unconventional

N.A. Supply Demand Outlook

Alaska/ MacKenzie

Decline or Sustain

Traditional Growth

Non-Traditional Growth

Western Canada

Eastern

Canada

Rockies

HeartlandSan Juan

Atlantic LNG

Western LNG Gulf Coast

Deepwater Gulf

North America Supply Profile

Hurricane Risk

Trinidad

Canada

Wyoming

San Juan

Deep Water GOM

Alaska

Permian Gulf Coast Louisiana

Mid-Continent

Gulf Coast South Texas

Mackenzie Delta

BP is the largest gas producer and reserves holder in North America

East Coast

Current production

Exploration interest

BP North America Supply Position

12/04/23 15

LNG

DW GOM

Alaska/Beaufort

bp – part of the solution

Onshore

Supply Solutions

E. Canada

West LNG

U.S. LNG Re-Gasification Terminals

LocationSendout Capacity

(Bcf/d)

After Expansion

(Bcf/d)Year

2001 Storage

(Bcf)

Everett, MA0.55 0.92 2005 3.5

Cove Point, MD* 0.75 1.00 2005 5.0

Elba Island, GA 0.45 0.86 2005 4.0

Lake Charles, LA 0.63 1.20 2005 6.3

Total 2.4 4.0 18.8

* Re-activated August 2003 Source: EIA

Current LNG deliveries estimated between 1.4 – 1.6 Bcfd

Getting Gas Safely To You

Producing Wells Compressor Station

Processing Plant

Compressor Stations

Supplemental Fuels (LNG)

Industrial Users

& Power Plants

Commercial Users

Residential Users

Underground Storage

Interstate Transmission Lines Approximately 280,000 Miles in U.S.

Distribution Mains (Lines) Approx. One Millions Miles in U.S.

Source: EIA

N.G. Pipelines & Key Trading Points

Natural Gas Market

U.S. Natural Gas Markets

Pre 1978 - Value Chain Regulation

* * *

* Regulated Pricing

Producers Pipelines Local Distribution Companies

End Users

U.S. Natural Gas Markets

Pipelines

Marketers

Current - Transportation, distribution and storage services unbundled. Emergence of wholesale marketers

**

*

*Producers Industrials

LDCs

ElectricUtilities

Generators

End Users

* Regulated Pricing

3,997

3,399

2,7482,545

2,289

0

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2500

3000

3500

4000

4500

2002 Production, Source: Company Financial Reports

MMcfd

CanadaUS

Note: Devon volumes do not include Ocean Energy

Top North America Gas Producers

Source: Gas Daily, S&P ratings as of June 18, 2003

Top North America Gas Marketers

B+

BBB+

BBB

B-

BBB+

A-

BBB+

A-

B

AA+

S&P Rating

2.83.5Oneok9

10.54.0Reliant7

4.68.8ConocoPhillips5

9.59.5Sempra4

5.43.5Williams10

2.23.5Nexen8

3.84.2Cinergy6

9.29.9Coral3

21.412.6Mirant2

14.920.1BP1

1Q021Q03CompanyRank

B+

BBB+

BBB

B-

BBB+

A-

BBB+

A-

B

AA+

S&P Rating

2.83.5Oneok9

10.54.0Reliant7

4.68.8ConocoPhillips5

9.59.5Sempra4

5.43.5Williams10

2.23.5Nexen8

3.84.2Cinergy6

9.29.9Coral3

21.412.6Mirant2

14.920.1BP1

1Q021Q03CompanyRank

PGE

New Energy

Noram

SCE

Sithe

Com EnergyPhillips JV

UPRPG&E

Pan- Energy

Mobil

TridentChevron

Destec

Illinova

PacifiCorp

Tenneco

DeepTech

Sonat

Coastal

PG&E

Calpine

SkyGen

Panda

CGCAVintage

Sheridan

Integrated

Energy Traders

Higher Prices

Supply Growth

Increased Drilling Decreased Demand

Lower Prices

Decreased Drilling Increased Demand

Supply Declines

Market Dynamics

The Energy Merchant Sector – Then

• The space vacated by the energy merchants will be filled

• LDC’s have been there, done that

AAA

BBB

Junk

Physical Financial

BanksProducers

LDC’S

IND’s

Energy Merchants

You cannot play the game from

this space

Fin

an

cia

l S

tre

ng

th

Business Emphasis

BP

The Energy Merchant Sector – Now

AAA

BBB

Junk

Physical Financial

BanksProducers

BP

You cannot play the game from

this space

Business Emphasis

Fin

an

cia

l Str

en

gth

New Entrants?

• It will take time to fill energy merchant gap

• Producers will start to fill, but have capability gap

• Banks moving here, but have infrastructure gap

LDC’S

Producers BanksDuke

Mirant

Reliant

Enron

Dynegy

WilliamsEl Paso

Reliant

DynegyMirantWilliams

Enron

El Paso

Duke

IND’s

Natural Gas Pricing

Regional Prices

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1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Alberta Rockies

Henry Hub California

Chicago New YorkAlberta

Rockies

California Chicago

Henry Hub

*

*

**

*

*

New York

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Henry Hub Natural Gas Prices [$/MMBtu]

A Wild Ride

An Even Wilder Ride in the Northeast

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Henry Hub

TETCO M3

$/MMBtu

Cold winter, declining storage levels, falling production, and high oil prices increasing both volatility and price.

Natural Gas Pricing

• Bidweek Cycle

• Gas Commodity Pricing– First-of-Month Index

– NYMEX Final Settlement / Basis trades

– Fixed Price Deals and Hedging

– Gas Daily prices

• Financial Instruments Supporting Physical– Index Swaps (premiums/discounts)

– Fixed for Float Swaps

– Basis Swaps

– Swing Swaps

Options

Settlement

Futures

SettlementFOM Nov Cash Trading

S M T W Th F S

Oct 27 28 29 30 31 Nov 1

First of the Month Index

• Most common pricing used by end user and producer

– used as benchmark by some customers

• Market price

• Premium / Discount associated with Index

– dependent on monthly market conditions

• Average of physical deals transacted during last three business days prior

to month of sale

• Inside FERC most commonly used

– prices sent in by different market sectors for publishing

• NYMEX Final Settlement – 3rd Business day prior to month end

• Basis quotes from brokers, marketing companies, and electronic

trading systems. Primarily at liquid points.

• Increased volatility in market area basis vs. supply basins, primarily

due to transportation economics and demand profile

• Basis swaps used to convert to FOM Index

Pricing Based on Final Settlement

Customer

(physical gas)BP

Bank/Broker (financial)

NYMEX +90¢

NYMEX +85¢

INDEX

Gas

• BP sold supply at NYMEX related pricing

• BP buys basis swap to convert to synthetic index

Basis

Swap

Converting NYMEX Priced N.G. to Index

Daily Pricing

• Daily volatility can be significant, especially in peak heating or cooling season (peaking power plants)

• Pricing only at liquid points or hubs

• Gas Daily publication most commonly used

• Gas Daily or Swing Swaps used to manage risk

Producer BP

Counterparty

FOM Index

DailyPrices

Gas

FOMIndex

• Producer wants Index for gas

• BP wants to pay daily price

• BP buys gas daily swap Gas Daily

Swap

•Converting FOM Index to Daily

Gas Daily Swap

BP

Counterparty

Customer

Daily Prices

Gas

DailyPrices $1.80

• Customer wants daily price

• BP wants fixed price

• BP sells swing swap

Swing

Swap

•Converting Daily Price from Customer to Fixed Price

Swing Swap

Calendar Spreads

• Buying and selling future calendar months

• Requires market view

• Historical analysis key indicator

• Fundamental analysis, i.e. weather forecast, storage balance, nuclear plant maintenance schedules, etc.

2.002.102.202.302.40

2.502.602.702.802.90

Mar Apr May Jun Jul Aug Sept Oct Nov

Contango

5.305.405.505.605.705.805.906.006.106.206.30

Backwardation

ContangoBackwardation

• Buy one locational basis, sell another

• Historical analysis required

• Fundamentals reviewed, I.e. supply / demand forecasts, pipeline constraints, storage balances, nuclear plant outages, capacity release in the market, etc.

Basis Spreads

Supplier

(physical gas)BP NYMEX

NYMEX -16¢

NYMEX

Gas

Gas

Daily

Customers

DailyGasPrice

Gas

Daily

Suppliers

DailyGasPrice

Gas Henry Hub

Tennessee

•BP buys NYMEX based gas at one location

•BP sells NYMEX based gas at another location

•BP takes long and short into daily market to capture spread

BP makes money when daily spreads are below 16¢

Basis Spread Example

Summary

• Market is responsive – understanding of fundamentals imperative for successful trading

• Timely Information = $$$$

• Financial instruments offer flexibility and risk management.

• Innovative product offerings for growing customer needs. Marketing companies must be engaged, open to new ideas, and have good credit.