I created this page on how to trade natural gas as a reference to the most important things one would need to know about this commodity, in order to make profitable options trades. This page is updated regularly. If you want details on it’s physical properties, read it’s wikipedia page as well.
Natural gas (NG) is a fossil fuel, an energy source, which burns much cleaner than oil or coal. It is mostly used to power electric power plants, run cars, domestic cooking and heating, and creating fertilizer. Coal power plants have been converting to natural gas power plants, because of its clean qualities.
Distribution of electricity generation methods. Source: EIA
It is a unique commodity, in that it is overly difficult to ship in it’s gaseous form, therefore has historically been a local commodity. Long intercontinental pipelines are just not worth building. This means, that it’s pricing on the US markets is generally not affected by geopolitical events, as is oil for example.
Technological advances have been made, which enables the producer to convert NG to liquid form (called LNG, or liquefied natural gas), and compressed natural gas (CNG). This has sparked increased intercontinental shipments of NG in recent years.
Natural Gas Deposits
At this moment in time, international suppliers of natural gas does not heavily affect NG trading, due to the factors listed above. To have a better oversight of the global gas market, here are the areas with the worlds biggest natural gas deposits:
Country Proved Natural Gas Reserves 2014 (in trillion cubic meters) (Source: cia.gov)
- Russia 47.8
- Iran 33.8
- Qatar 25.1
- United States 8.7
- Saudi Arabia 8.2
- Turkmenistan 7.5
- United Arab Emirates 6.1
- Venezuela 5.6
- Nigeria 5.1
- Algeria 4.5
USA natural gas production
The US produces much of it’s gas needs, and imports what it needs mainly from Canada and Mexico (EIA natural gas import breakdown).
USA exporting of natural gas is low (EIA natural gas imports & exports), and is a topic of ongoing political debates (link 1). The first LNG export facilities are to be opened at the end of 2015 by Cheniere Energy (ticker: LNG). Activist investor Carl Icahn has acquired a 10% stake in the company as of 9/17/2015, so he is betting big on the success of the export of liquefied natural gas.
US domestic production has been on the rise (EIA natural gas production), mainly due to shale fracking. There are 4 main geological sources of gas. Production from shale formations has been driving USA production of natural gas in the recent years.
Factors affecting price of natural gas contracts
Weather patterns
Gas is used for heating and cooling as well. Power plants account for 33% and US households account for 49% of the natural gas demand. Mild weather estimates could curb the demand for natural gas, and negatively influence NG prices.
Seasonally typical weather is priced in at any given time, but forecasts for atypical weather conditions in either direction affects the price of natural gas. Changes in existing forecasts can also cause price movement.
Look for unseasonably warm or cold weather reports in larger areas of the US, and deviations from the normal HDD or CDD. (Oh, what is HDD exactly?) Here is EIA’s report on the average us HDD and CDD.
Also, natgasweather.com has some relevant forecasts and info.
Winter weather
Historically, wintertime will bring the highest volatility in NG prices. Natural gas is used for heating in half of US homes, so if it turns out to be a harsh winter, NG prices could skyrocket by several 100%, as they did in
Supply vs demand
There is a growing demand for natural gas, as more coal plants are closed. Here is a chart of the consumption of gas in the US, and here is the production.
Storage reports
The EIA releases it’s weekly storage report on Thursdays at 10:30 eastern time. You can view it’s summary here, and the detailed report here. If analyst consensus is wrong, you will see an instant movement in NG’s price.
Regulatory environment
Shale gas is produced via hydraulic fracking, a relatively new method full of controversies, due to it’s impact on the environment. As more information is gathered on the topic, restrictions could be put in place, which would reduce production. This needs to be monitored.
Oil
Natural gas has a fair amount of correlation with oil prices, with the May 2014 to May 2015 correlation coefficient at 0.46.
A lot of equipment is shared with oil production, and natural gas sometimes accompanies oil finds as well. Natural gas located in oil fields is referred to as “associated”, and vice versa, NG discovered in a dedicated gas field is called “unassociated”.
The correlation is relevant, but not super strong, so don’t let it guide your pricing.
Trading natural gas
If you want to trade natural gas with futures or options, you have 2 main choices. These instruments have liquidity in options as well.
- Natural gas – futures symbol /CL
- Traded on the CME for delivery at the Henry Hub in Louisiana
- Contracts priced in USD per million British thermal units (mmBtu) and each contract represents 10,000 mmBtus
- Expiry of options not uniform, here are the expiration dates
- Unites States National Gas Fund – symbol UNG
- An ETF that tracks the near month contract of /CL in percentage terms as its benchmark
- If the near month contract is within 2 weeks of expiration, the benchmark becomes the next month’s contract
- Expiry every 3rd Friday of the month