Basis is a term used in energy trading to describe the difference between two methods of setting prices. Examples of basis include:
- Locational basis – the difference in price between two locations
- Calendar basis – the difference in price between two specific dates
- Contractual basis – the difference between actual cash prices trading in a market and an index used to set a price in a bilateral contract
Basis risk refers to the risk in trading positions associated with a specific type of basis. For example, a gas marketer may contract to buy gas at a price indexed to Henry Hub in Louisiana but may be contracted to sell the gas at a fixed price in New York City. The marketer is exposed to locational risk determined by the basis between Henry Hub and New York City. Basis risk is sometimes hedged by trading basis swaps.
This graph shows the montly price differential (locational basis) between Henry Hub in Louisiana and the New York City Hub. Note that the basis is largest in summer and in January. This is because these are high demand months in New York. Due to limited pipeline capacity into the New York market, prices rise during high demand since supply becomes scarce. But prices do not rise similarly at Henry Hub because supply is not constrained there.