1. NY Transco Zone 6 natural gas user hedges the December purchase with a Henry Hub futures contract expiring at the end of November. The locked-in futures price is $2.95. NY Transco Zone 6 usually trades above Henry. To hedge basis risk the user decides to enter into a basis swap agreement for a fixed price of $1.20.

a. Does the natural gas user buy or sell the basis swap?

b. At the end of November, Henry Hub contract settles at $3.06 and the spot price at Transco Zone 6 is $4.00. Using a diagram, please show all exchanges between the gas user and the spot market, the futures exchange, and the swap counterparty. Please also show all cash inflows and outflows.

c. What is the price the user ends up paying for the gas? Would it have paid more or less without the swap?