Natural gas may sound like an uncomfortable party foul, but it's also a fossil fuel, and the second-most frequently traded energy futures contract.
Much like petroleum, natural gas is found in deep underground rock formations and is created when layers of decomposing organic material are exposed to intense heat and pressure. The energy previously collected by those organisms via the sun is then (over long periods of time) transferred into the chemical bonds that make up natural gas.
We're taking a closer look at natural gas on the blog today because prices have perked up in recent weeks and the potential for trading opportunities may increase in the near-to-mid-term.
When considering natural gas futures one of the most commonly referenced contracts is the "Henry Hub." Located in Louisiana, Henry Hub is the physical intersection of 16 natural gas pipelines that draw from around the United States. "Henry Hub" also lends its name to natural gas futures contracts traded on the New York Mercantile Exchange (NYMEX) and the over-the-counter (OTC) swaps traded on the IntercontinentalExchange (ICE).
As detailed on an episode of Futures Measures, natural gas prices dipped so low in early 2016 that prices were getting down to levels last seen in 1998. The situation developed in large part because of consistent gains in worldwide production due to technology improvements (i.e. fracking) and decreased demand attributable to warmer winters.
In March of 2016, natural gas traded down to lows of $1.64 per million British Thermal units (mmBtu) (as a comparison, from 2004 to 2009 prices were consistently above $6 mmBtu). Also in March of 2016, the Energy Information Administration (EIA) reported that natural gas inventories were about 2.4 trillion mmBtu - roughly 41% over the 5-year average for that time of year.
Pete Mulmat, tastytrade's resident futures expert, suggests that the combination of low prices and record inventories would eventually translate to reduced production - a situation that in his opinion could ultimately lead to higher prices.
Fast-forwarding to today, mid-June 2016, and much of what Pete predicted on Futures Measures in March has indeed come to pass. Natural gas prices this week hit their highest mark since September 2015 with a mark of $2.60 mmBtu. And while inventories have increased to 2.9 trillion, the rate at which they are building has slowed significantly - meaning production is finally decreasing.
No matter your current stance on the direction of natural gas prices, you may be searching for further information on how you can trade this commodity and/or some potential strategies that may fit your outlook and risk profile.
If that's the case, you’ve come to the right place.
For more information about how seasonality affects natural gas trading, we recommend you watch this episode of Closing the Gap - Futures Edition. If you want to learn more about how the current El Niño cycle might affect natural gas prices, we also recommend this episode of Futures Measures.
Another episode that I found very useful is an episode of Closing the Gap - Futures Edition that described the construction and deployment of a bullish natural gas spread back in March using the May and June contracts, as well as a put on natural gas. The trade constructed on this show actually worked out quite well, and could serve as an useful example for those interested in getting serious about the natural gas trade.
If you want to further “geek out” on natural gas spreads and the reasoning behind them, this episode is a must: Closing the Gap - Futures Edition.
No matter your current portfolio or predisposition toward futures trading, an increased awareness of the market and its constituents generally helps us better understand how all the puzzle pieces fit together.
If you have any questions about trading natural gas we hope you’ll reach out at firstname.lastname@example.org or leave a comment below.
We look forward to hearing from you!
Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.