Natural Gas Futures Trading Basics

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Natural Gas Futures Trading Basics

Natural Gas futures are standardized, exchange-traded contracts in which the contract buyer agrees to take delivery, from the seller, a specific quantity of natural gas (eg. 10000 mmbtus) at a predetermined price on a future delivery date.

Natural Gas Futures Exchanges

You can trade Natural Gas futures at New York Mercantile Exchange (NYMEX).

NYMEX Natural Gas futures prices are quoted in dollars and cents per mmBtu and are traded in lot sizes of 10000 mmBtus .

Exchange & Product Name Symbol Contract Size Initial Margin
NYMEX Natural Gas Futures
(Price Quotes)
NG 10000 mmBtus
(Full Contract Spec)
USD 8,775 (approx. 16%)
(Latest Margin Info)

Natural Gas Futures Trading Basics

Consumers and producers of natural gas can manage natural gas price risk by purchasing and selling natural gas futures. Natural Gas producers can employ a short hedge to lock in a selling price for the natural gas they produce while businesses that require natural gas can utilize a long hedge to secure a purchase price for the commodity they need.

Natural Gas futures are also traded by speculators who assume the price risk that hedgers try to avoid in return for a chance to profit from favorable natural gas price movement. Speculators buy natural gas futures when they believe that natural gas prices will go up. Conversely, they will sell natural gas futures when they think that natural gas prices will fall.

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The price of natural gas fluctuates from moment to moment, as it is publicly traded on an exchange. The price of natural gas is determined by global supply and demand for the physical commodity, as well as the expectations and supply and demand from traders. Day traders don’t assess the “real” value of natural gas. Instead, day traders profit from daily price fluctuations in the commodity, attempting to make money whether it rises, falls or its value stays nearly the same.

Futures Markets

Day trading natural gas is speculating on its short-term price movements. Physical natural gas isn’t handled or taken possession of, rather all the trading transactions take place electronically and only profits or losses are reflected in the trading account.

There are a number of ways to day trade natural gas. One way is through a futures contract. A futures contract is an agreement to buy or sell something–like natural gas, gold, or wheat–at a future date. Day traders close out all contracts (trades) each day and make a profit or loss on each trade based on the difference between the price they bought the contract and the price they sold it.

Natural gas futures trade through the Chicago Mercantile Exchange (CME Group). There are several types of natural gas, and contracts, which can be traded. The most heavily traded contract, preferred by day traders, is the Henry Hub Natural Gas Futures (NG). Each contract represents 10,000 million British thermal units (mmBtu).

On the futures exchange, the price of natural gas (NG) fluctuates in $0.001 increments. This increment is called a “tick”–it’s the smallest movement a futures contract can make. If you buy or sell a futures contract, how many ticks the price moves away from your entry price determines your profit or loss. To calculate your profit or loss (your trading platform shows you, but it’s good to understand how it works) you’ll first need to know the tick value of the contract you’re trading.

For a Natural Gas contract (NG) the tick value is $10. This is because the contract represents 10,000 mmBtu, and 10,000 mmBtu multiplied by the $0.001 tick size results in $10. That means for each contract, a one tick movement will result in a profit or loss of $10. If it moves 5 ticks, you win or lose $50. If it moves 5 ticks and you’re holding 3 contracts, your profit or loss is $150.

Trading Accounts and Margin

The amount you need in your account to day trade a natural gas (NG) futures contract depends on your futures broker. NinjaTrader for example, requires you have $1000 in your account to open a day trading position for one natural gas (NG) contract. You also need enough in the account to accommodate for potential losses (need much more than $1000).

These figures assume you’re day trading and closing out positions before the market closes each day. If you hold positions overnight, you are subject to Initial Margin and Maintenance Margin requirements, which will require you have more money in your account.

ETFs and Stock Market NG Plays

Another way to day trade natural gas is through a fund which trades on a stock exchange, like the United States Natural Gas Fund (UNG). Or, if seeking a more volatile option (moves three times as much each day), the 3X Long Natural Gas ETN. If you have a stock trading account you can trade the price movements in natural gas.

The 3X Inverse Natual Gas ETN (DGAZ) is another popular natural gas ETF. Since it is an inverse fund, it moves in the opposite direction of the natural gas price, on a daily basis.

The intraday price movements of these products are reflective of daily (not long-term) percentage price changes in natural gas.

The products trade like stocks. The minimum price movement is $0.01, therefore you make or lose $0.01 for each share you own each time the price changes by a penny. Stocks and ETFs are typically traded in 100 share blocks (called lots) so if the price moves a penny and you’re holding 100 shares, you make or lose $1. If the price moves $1, from $5 to $6, you make or lose $100 on your 100 share position. If you are holding 500 shares, you make or lose $500 on that same price move.

The amount you need in your account to day trade a natural gas ETF depends on the price of the ETF, your leverage, and position size.

To become a day trader of stocks or ETFs in the U.S., you need to have a $25,000 minimum trading account balance. Depending on how much income you want to generate and your leverage, you may wish to have more than $25,000 available to you.

The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.

A Natural Gas Primer

Natural gas is playing a larger role in the energy industry. Once thought of as a byproduct of oil production, natural gas is now used in a variety of ways, from residential uses to industrial, to electricity generation. Natural gas cars are now a reality, with around 12.7 million natural gas vehicles worldwide as of 2020. It is the cleanest burning fossil fuel and economically friendly, contributing to about 25% of the United States’ energy use, so it is no wonder why it is serving as an alternative to other fossil fuels. With this in mind, investors should be armed with the information they need to make the proper investment decisions regarding natural gas investments. Going through who uses natural gas, how it is transported, its storage capabilities, pricing, trading methods and spot and forward markets, investors will have the tools they need to better understand this clean burning commodity.

Nationally, the single largest factor affecting demand for natural gas is temperature. During the winter, natural gas is used for heating while during the summer, it is often used to power air conditioners. The demand and price of natural gas thus fluctuates whether it is summer or winter. During the winter, demand is at its peak and so prices adjust accordingly. (For related reading, see Become An Oil And Gas Futures Detective.)

Users of Natural Gas
The three largest users of natural gas are industrial, domestic and power generation. Of the three, the use of natural gas for power generation has risen the quickest. By getting to know who uses natural gas, investors can better gauge how demand affects pricing.

Industrial
Industrial users often use natural gas as a source of heat. It ignites quickly and turning off a natural gas furnace doesn’t waste any fuel. Stopping the fuel source can easily put out a natural gas furnace. In comparison, a coal furnace will continue to burn until the coal is depleted. This makes it far more expensive if the coal furnace has to be started more than once.

Domestic
The largest residential use of natural gas is home heating, especially in the winter. About half of the homes in North America use natural gas for heating. Other uses include boilers, furnaces, water heaters and outdoor barbeque grills. It can burn up to 2000°F (1093°C) from a simple stovetop, making it a powerful domestic cooking fuel.

Power Generation
Power plants are the fastest growing users of natural gas, since natural gas powered plants are more environmentally friendly than coal or oil based plants. Some natural gas power plants operate year round, while others are more seasonal.

Transportation
Natural gas is most commonly transported via pipelines. This is primarily due to natural gas having a relatively low amount of energy per volume and the additional cost that containers would add. To compare, a barrel of oil has the same energy content as about 6,000 cubic feet of natural gas or a 6:1 ratio. An alternative is liquefying natural gas to get more energy content per volume. This is not as cost effective as transporting via pipelines however, as it needs to be cooled to -260°F (-162°C) to be liquefied. As a result, it is primarily used in this form for storage or for natural gas cars. To get an idea of how much power even liquefied natural gas (LNG) contains compared to gasoline, LNG only holds about two-thirds the energy for the same volume.

Storage
Depleted Gas Reserves
Economically viable due to being able to be reused, depleted gas reserves are the most common and cheapest form of underground storage. Typically, these storage facilities are operated on an annual cycle, withdrawn during the peak winter months and injected with gas during the off-peak summer months. How close the depleted gas reserve is to the pipeline infrastructure and key gas markets, also plays into how economically viable the storage will be. To maintain the proper amount of pressure in depleted reserves, about 50% of natural gas must be kept as cushion gas.

Aquifers
Underground permeable gas formations, aquifers act naturally as water reservoirs. More costly than depleted gas reserves, the entire infrastructure must be developed from scratch, everything from the installation of wells and pipelines. Because of this, aquifer store requires more natural gas cushion than a depleted gas reserve. About 80% of the total gas volume is cushion gas.

Salt Caverns
Salt caverns are well suited for natural gas storage. The walls are strong and gas cannot leak. Cushion gas requirements are low, typically around 33% of total gas capacity. However, salt caverns are smaller than depleted gas reserves and even aquifer storage facilities, typically only holding about one-one-hundredth of the amount of storage of a depleted gas reserve. One key advantage, however, is the ability to quickly store and remove natural gas resulting in more withdrawal and injection cycles per year, as compared to the previous two methods.

Natural Gas Hub
A hub is where two or more pipelines connect with each other. The most important hub for natural gas in North America is the Henry Hub, located along the U.S. Gulf Coast. Here, the benchmark for natural gas prices is determined and traded for delivery on the NYMEX natural gas futures contract. It is the average of the natural gas prices traded at this location from 13 interconnected pipelines. (For related reading, see Fueling Futures In The Energy Market.)

Pricing
Natural gas trading terminology is different than other markets. When quoted by a trader, the price is the difference between the Henry Hub price and that location’s price, called the basis price. Basis differentials can be caused by weather, natural gas pipeline capacity, among other factors. However, if you ask a utility operator the price, it would often be the actual price of natural gas. Regardless of the price quoted, the cost is the same to the consumer. Based on this terminology, a trader may make a basis position having exposure to two different locations: the Henry Hub price and that location’s price. An actual position, also referred to the all in price, the trader would be exposed to the price of gas at only one location.

Trading
There are several methods of trading natural gas. The simplest is taking a directional position, profiting from whether the price goes up or down depending on the position taken. However since natural gas is cyclical, traders tend to speculate on the price taking spread trades. Here are a few:

Swing Trades
This is where an investor would buy natural gas when it’s priced low and sell it when it is priced high. This is only possible if the trader can store natural gas for a set period of time. Since even on a weekly basis natural gas prices can be volatile, it is possible to buy during a low demand time period and sell when demand picks up, say at the start of the week. (For related reading, see Introduction To Swing Trading.)

Location Spreads
This is betting on the price difference between two locations. As the price of natural gas can vary from location to location, there can sometimes be a substantial difference between the two locations. This is not helped by natural gas transportation not being instantaneous and storage can be limited.

Heat Rates
These trades are based on the difference between natural gas and electricity pricing. Generally, the two trade together, but since they are determined using different mechanisms the prices can sometimes differ, with traders taking advantage of the volatility.

Time Spreads
Also called calendar spreads, these trades are where the trader bets, for example, that the summer will be warmer than usual, boosting natural gas prices, thus buying summer gas and selling winter gas. (For related reading, see Pencil In Profits In Any Market With A Calendar Spread.)

Exposure Opportunities
While trading natural gas futures can be an option, other alternatives include investing in fully integrated natural gas companies or getting exposure through natural gas ETFs. It is up to the investor and their situation and sophistication to decide which method to use.

Inventories
For trading natural gas, the U.S. gas inventories report is often used to gauge current supply and demand from the previous week. This is issued by the Energy Information Administration (EIA) every Thursday afternoon at 3:30 p.m.

Spot and Forward Prices
Spot markets are prices for immediate delivery, whereas future markets are for delivery for some time in the future. These are two very distinct markets that are fundamentally different in the natural gas market.

In the spot market, the prices are the supply at hand and demand at hand; if there is a shortage then prices can act erratically, as it is difficult to move extra supply from storage on such short notice. In comparison, the futures market is less volatile, mostly being determined by macroeconomic variables of seasonal supply and demand expectations.

As a result of this key difference between forward and spot markets, the pricing closer to the delivery becomes less certain. This is because any complications in delivery can have an adverse effect on natural gas prices. However, this volatility in the spot market does not typically affect the forward pricing. Forward pricing tends to follow a regular pattern: high prices during the winter and lower during the summer. (For related reading, see What Is The Difference Between Forward and Futures Contracts?)

The Bottom Line
Investing in commodities such as natural gas can be complicated and hard to understand. Natural gas use is becoming more prevalent and by knowing the fundamentals of natural gas, investors can make better decisions on when to buy or sell.

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