What are Natural Gas Futures?
Natural Gas futures are useful financial instruments used by producers and marketers to manage the risk of price fluctuations in the natural gas market.
A natural gas future is a standardized contract that is traded on an exchange between two parties. The buyer of the contract agrees to accept delivery of a specified quantity of natural gas at a predetermined price at a future specified date. The seller agrees to supply such a quantity as per the contract.
Natural gas has the second-highest volume of futures contracts based on a physical commodity, and these futures are famously volatile.
What is Natural Gas?
Called the “fuel of the future,” Natural gas is one of the world’s most popular fossil fuels and is widely used as a source of energy since it is a clean burning fuel. Currently, natural gas is responsible for more than half of the residential and commercial energy used in the world, and makes up around 41% of the energy used in the U.S.
As a prominent fuel source, natural gas is used to power automobiles, and run heating and air-conditioning systems in homes. Since it is greener than gasoline, many environmentalists have called for natural gas to replace gasoline as transport fuel.
Natural Gas is crucial to a wide range of industrial processes. It is utilized in electricity generation and to manufacture organic chemicals like plastic. It is preferable to coal or oil since it is cleaner and friendlier to the environment than other fossil fuels.
Natural gas is found in coal beds, oil fields (natural gas here is often called “associated”) and natural, dedicated gas fields (called “unassociated” natural gas), where it can be formed in one of two ways: biological or thermogenic. The biological method of generation involves methane-producing microorganisms in swamps or shallow water. The thermogenic method involves pressure acting on organic matter deep underground.
Once extracted, natural gas undergoes quite a degree of processing, with non-methane components removed. Natural gas is refined by removing impurities, including water, to create marketable dry natural gas. This process produces by-products like ethane, propane, butanes and helium that are cleaned at a gas processing plant and used in a variety of ways.
In the past, oil companies used to dispose extra, unwanted natural gas by burning it (this process is known as flaring)—however, flaring is now illegal in the U.S. Instead, excess natural gas can now be stored underground in depleted oil fields, hollow salt caverns, reservoirs or aquifers. This helps local distribution companies, producers and suppliers manage their inventory and avoid imbalances in supply and demand.
Natural Gas is transported to end users usually via high-pressure, long-distance pipelines. Since natural gas is colorless and odourless, a small amount of chemical mercaptan is added to it before distribution to give it a distinct rotten egg smell that makes it easier to detect leaks.
Historically, it has been problematic to supply natural gas to or from remote areas. However, with growing infrastructure and technological innovations, natural gas has become easier to transport and store. Natural gas can also be converted into liquefied natural gas (LNG) or compressed natural gas (CNG) temporarily for easier transport over long distances using ships.
Still, it is not always feasible to be transported over long distances, especially if it involves crossing oceans, and hence, natural gas is usually a locally consumed commodity.
Brief History of Natural Gas
Naturally occurring gas has been recognized since ancient times. In around 1000 B.C., the famed Oracle at Delphi on Mount Parnassus in ancient Greece had natural gas emerging from the ground—where it was used to light a flame. The Chinese on the other hand, burned natural gas around 500 B.C. to boil sea water into a drinkable condition.
French explorers discovered naturally occurring natural gas in the United States in 1626 and in 1821, William Hart dug the first natural gas well in Fredonia, New York. The Fredonia Gas Light Company was the first American natural gas distribution company in the country.
Commercialized natural gas first began to be used in 1785 in Britain, to light houses and streets. In the U.S., Baltimore was the first city to use manufactured natural gas to light its streets in 1816.
Initially natural gas was mostly used as an energy source to produce light. By 1855, Robert Bunsen invented the Bunsen burner, which demonstrated how gas could be generate heat for cooking and heating. In the 20th century, with pipelines expanding across the country, natural gas also began to be used for home appliances and heating, and also in manufacturing in industrial plants.
Where is Natural Gas Produced?
Natural gas can primarily be obtained from four main sources. Gas rich shale holds natural gas in abundance and is currently being explored extensively in the U.S. The gas can however migrate into other formations as well, thereby creating new sources of natural gas. Natural gas can get trapped into sandstone lying over gas-rich shale. This is known as conventional gas accumulation. Then there are tight-sand accumulations, where natural gas migrates from its sources to a sandstone formation deep down. Lastly, gas can also be created when coal is being formed.
The total estimated reserves of natural gas in the world are expected to last over 250 years at the current consumption rate. Russia is the world’s largest supplier of natural. Iran, Qatar and other Middle Eastern countries follow Russia in terms of supply. Russia also has the world’s leading proved reserve of natural gas, with 47 trillion cubic meters of natural gas. Iran has around 29 trillion and Qatar 25 trilion.
The world’s largest natural gas field the North Field is off the shore of Qatar, and holds up to 25 trillion cubic meters of natural gas, which can last the world up to 200 years.
The U.S. has 6.9 trillion cubic meters of natural gas reserves currently and even though 99% of the natural gas used in the U.S. is supplied from within the country via the two million-mile underground gas delivery system, the U.S. is currently a net importer of natural gas.
In 2012, the United States imported around 6% of its total natural gas consumption, mostly from Canada. A small amount of natural gas is also shipped to the United States as liquefied natural gas (LNG). But net imports are declining in recent years (the net import in 2007 was 16% of consumption) due to the surge in domestic protection.
The U.S. also exports natural gas to Canada and Mexico. Canada accounts for 61% of pipeline natural gas exports, with Mexico accounting for the rest.
Till 1986, natural gas production in the United States was in line with consumption. Demand increased after that and the U.S. began importing natural gas. However, thanks to efficient, cost-effective drilling, production has also increased in recent years from 2006 to 2011.
The U.S. has been discovering many natural gas reserves lately, which has decreased natural gas prices and improved natural gas’s prospects in the economy. The largest natural gas deposits are found in Arkansas, Louisiana, Alaska and Texas in the United States. The top producers are Texas, which produces 29% of the U.S. production, following by Louisiana (13%) and Wyoming (9%). One of the largest gas reserves in the U.S. is at the Haynesville Louisiana.
How is Natural Gas Used (United States)?
Natural gas contributes to around 25% of the energy used in the United States. The U.S. consumption was 25.46 trillion cubic feet of natural gas in 2012. The top natural gas consuming states in 2011 were Texas, California and Louisiana.
Who Invests and Trades Natural Gas Futures?
Natural Gas is an in-demand future and is traded by mainly two categories of people: hedgers and speculators.
Producers and Marketers of Natural Gas are hedgers who use futures to fix a selling price for their forthcoming production of natural gas, so that they will get a specified amount of the contract even if prices fall in the future. Consumers of natural gas (businesses that need Natural Gas for manufacturing other products) use futures to set a fixed purchase price for a specified quantity of Natural Gas that they would like to buy in the future. Both producers and suppliers try to use futures as a way to minimize the risk from price fluctuations in the market of Natural Gas.
Natural Gas futures are also traded by speculators. Speculators have no vested interest in the underlying asset, that is, they will neither deliver Natural Gas nor take delivery for Natural Gas. They take on the price risk and try to capitalize on price movements to make profits.
Natural Gas Futures Contracts
Natural Gas futures, including the most popular Henry Hub futures, trade on the New York Mercantile Exchange (NYMEX) and the Chicago Mercantile Exchange (CBOT) in the United States. A contract represents 10,000 million British thermal units (mmBtu) and trade under the symbol “NG.” These are highly liquid, extremely active contracts that trade throughout the year. Contracts are listed for the current year plus the next 12 years and are priced in dollars and cents per mmBtu. The contract is based on delivery at the Henry Hub in Louisiana—where 16 natural gas pipelines converge.
Natural gas futures also trade on the Intercontinental Exchange (ICE), which offers both UK Natural Gas Contracts and Title Transfer Facility (TTF) futures. The Multi Commodity Exchange (MCX) in India too offers natural gas futures throughout the year.
How to Trade Natural Gas Futures: Costs and Different Brokers
You can trade futures by opening a trading account with a trusted broker who handles futures trading. Starsupply Commodity Brokers, CME Globex, CME Clear Port and Etrade are some well known online platforms for trading futures.
Most brokerages will charge the National Futures Association fees, which is roughly around $0.02 per side, along with a commission (which can range from $0.025 to $3 and more, per contract per side). You will also have to pay an exchange fee, which will vary depending on the exchange and the specific contract you are trading. Be sure to look at the fine print and add up all the fees into your cost.
Price movements in the natural gas futures market are sometimes unpredictable and erratic, and have earned natural gas a notoriety in the commodity world. Some traders can experience huge losses due to erratic price movements, however there are large profits to be made if futures traders employ smart strategies and carefully hedge the risks mentioned below.
Natural Gas futures trading is accompanied by several risks affecting the underlying commodity. Natural gas is usually limited in its supply range, so its market dynamics in the United States are fairly insulated from world events, specially from the Middle East, which affects several other commodities like crude oil. Natural gas prices in the U.S. are however affected by the health of the U.S. economy, inventory levels, threats from cleaner sources of energy, unexpected weather changes (demand for natural gas used in automobiles, air conditioners can be affected), supply problems, environmental regulations (specially with regard to gas fracking), new discoveries of massive reserves in the U.S., Israel and Australia, etc.
There is one risk in particular that traders should be aware of. Every Thursday, the Energy Information Administration releases a report at 10:30 pm ET with data about the current natural gas storage and inventory. The markets react sharply to such data which allows short term traders an opportunity to profit from price swings whenever new inventory data is released.
There are also the risks typical to financial trading. Natural Gas futures have a lot of leverage, which allows traders to control a large amount of commodities for a small amount of investment. However, it also means that even a small, unfavorable change in the prices of natural gas can drastically impact a traders’ entire equity.
Despite these risks, natural gas futures are highly in demand since they are liquid, witness high daily volumes and offer a strong investment factor due to the positive relationship between natural gas prices and the state of the U.S. economy.