Midwest Gas Basis-A Bear Trap?

For participants in Midwest gas markets, the question is whether the unusually large negative Midwest basis that occurred in the fourth quarter of 2005 and continued well into 2006 was a one time event caused by hurricanes or the start of new relationships. CERA believes that most of large negative Midwest basis was the result of market reactions to the large, but temporary, loss of gas supply caused by Hurricanes Katrina and Rita, a classic bear trap on which Midwest gas market participants should not act. However, Midwest gas market participants need to understand that the effects of the hurricanes obscured some new relationships that will result in Midwest gas prices trading modestly lower relative to Henry Hub than historically even after all production loss to the hurricanes is restored. These new relationships include

* Pipeline capacity bottlenecks from East Texas and the Mid-Continent are putting downward pressure on gas prices in those areas relative to Henry Hub and indirectly on downstream Midwest gas prices. CERA does not expect these pipeline capacity bottlenecks to be eliminated until late 2007 or 2008.
* Recent and prospective increases in storage capacity in Michigan will increase the cyclicality of Michigan basis-higher positive basis in the summer and higher negative basis in the winter. This Michigan increase in cyclicality will directly affect the closely linked Dawn basis.
* The record high storage levels coming out of the winter of 2005/06 will reduce Midwest demand for storage injection gas this summer, causing summer Midwest gas prices to trade at lower levels relative to Henry Hub than historically.

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CERA Reports Online, a wholly owned subsidiary of IHS Energy, is a leading advisor to international energy companies, governments, financial institutions, and technology providers. CERA delivers critical knowledge and independent analysis on energy markets, geopolitics, industry trends, and strategy. CERA's expertise covers all major energy sectors--oil and refined products, natural gas, and electric power--on a global and regional basis.