Price index

A price index is a formula for calculating the market price of a commodity based on one or more sources of pricing information. A basic requirement for a competitive commodity market is open price discovery. This means that all participants have access to information about the market price of the commodity at specific locations. Indices, compiled from sources with actual market pricing information, provide this information. Indices are calculated for prices at specific locations. Commonly used locations are trading hubs, which are places where buyers and sellers transfer ownership of the commodity. In other cases, indices are calculated as an average across multiple trading points. 

Indices are commonly used to calculate prices for natural gas and electricity transactions. For example, a buyer of natural gas in a year-long agreement might agree to pay a price that is determined monthly based on the closing price of the CME NYMEX natural gas futures price.

Here's an example of index pricing for an electric power purchase agreement:

Indices are formulated in multiple ways. Here are three examples:

1. A basket of prices based on public information

For regions with an ISO, data from ISO prices averaged across multiple hours and in some cases multiple pricing points, can be used. For instance, it is common to use a peak price index that covers 16 hours across the day and an off-peak index that covers eight hours across the night. Some ISOs use pricing hubs that average regional prices to provide traders with more liquid points. An example is The Midcontinent ISO (MISO), which provides the market with prices at eight pricing hubs: Indiana, Illinois, Michigan, Minnesota, Arkansas, Louisiana, Mississippi, and Texas. 

2. A weighted average price based on exchange trading

Indices are also provided by operators of electronic trading exchanges such as the Intercontinental Exchange (ICE), CME, EEX, and JEPX.

3. Price surveys by market data companies or government agencies

Organizations such as S&P Global Platts and Natural Gas Intelligence provide indices for key trading points around the world based on deal reporting by traders. To ensure the integrity of the indices, regulators such as FERC in the U.S. monitor markets and can enforce penalties for market manipulation through false reporting. Price indices calculated by surveys are also provided in some areas by governmental agencies. An example is the monthly natural gas prices for trading regions determined by Mexico’s Energy Regulatory Commission (CRE). Prices are calculated using trading information filed each month by marketers active in Mexico.