Natural Gas Futures Trading Basics

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The Beginner’s Guide to Natural Gas Futures

By Alex McGuire , Associate Editor , Money Morning • @AlexMcGuire92 • March 25, 2020

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Natural gas is often defined by its utilities. It generates electricity, heats homes, and fuels vehicles.

Most investors are aware how natural gas is used. But not everyone understands how natural gas is traded.

Today we’re going to break down what natural gas futures are and how they work in the commodities market. Knowing how it’s traded every day lets you understand how it’s priced and how to interpret movements in natural gas futures.

What Are Natural Gas Futures?

A natural gas future – like all commodities – is a contract obligating the buyer to purchase a specific quantity of natural gas at a future date and price. Delivery dates are set around the 15th day of the following month. Futures are priced per million British thermal units (BTUs) – one BTU is the amount of energy needed to change one pound of water by one degree Fahrenheit.

According to Investopedia, a natural gas futures contract has 10 specifications:

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  • Ticker Symbol: NG on the New York Mercantile Exchange (NYMEX), ENG on the electronic Chicago Board of Trade (eCBOT)
  • Contract Size: 10,000 million BTUs
  • Deliverable Grades: Determined by pipeline specifications in effect at the time of delivery
  • Contract Months: All months of the year
  • Trading Hours: 9 a.m. to 2:30 p.m. EST on the NYMEX, 6 p.m. to 5:15 p.m. CST on the eCBOT
  • Last Trading Day: Trading ends three business days before the first calendar day of the delivery month
  • Last Delivery Day: Last business day of the contract month
  • Price Quote: Measured in cents per million BTUs
  • Tick Size: A “tick” is the minimum upward or downward movement a stock or future can move. For natural gas futures, it is $0.01 per million BTUs.
  • Daily Price Limit (not applicable in electronic markets): $3 per million BTUs; contracts may expand by $3 in either direction if they are traded, bid, or offered. If any contract is traded, bid, or offered at the $3 limit for five minutes, trading is halted for five minutes.

How Are Natural Gas Futures Traded?

A futures contract for natural gas can be traded on the NYMEX, Intercontinental Exchange (ICE), or Multi Commodity Exchange (MCX). The NYMEX is the commodity benchmark in the United States while the ICE and MCX are based out of the U.K. and India, respectively.

Like all other commodities, natural gas has its own ticker and contract value. These components help you figure out the best opportunities to trade and sell it.

If you’re buying or selling a natural gas futures contract, you’ll see a ticker handle like this: NGK15 @ 2.76.

Delivery Codes for Natural Gas Futures

Here’s the list of letter codes used in ticker quotes to specify the delivery month:

January – F

February – G

March – H

April – J

May – K

June – M

July – N

August – Q

September – U

October – V

November – X

December – Z

NG” denotes the commodity being traded is natural gas. “K” represents May – the month in which the natural gas must be delivered – and “15” represents the year. The “2.76” denotes the price per million BTUs being bought or sold at that time.

So the whole string put together represents the following: “I am buying/selling natural gas for May 2020 delivery at a price of $2.76 per one million British thermal units.”

Now we have to calculate the contract value, which determines how much your amount of natural gas is worth in the overall market…

The value of a futures contract can be calculated by multiplying the market’s current price by the contract’s size. Because a futures contract’s size is 10,000 million (10 billion) BTUs, you simply multiply the current price by 10,000.

If we stick to the above ticker’s price of $2.76, we’ve determined that the contract’s value in the natural gas market is $27,600.

How Have Natural Gas Futures Performed in 2020?

While the energy sector has struggled this year, natural gas has been much less volatile.

Gas futures have fallen about 5.4% in 2020. Meanwhile, WTI oil and Brent oil have dropped 12.8% and 7.3%, respectively (as of March 24).

Oil futures are more volatile because they’re tied to the world’s No.1 energy commodity. They’re exposed to complex geopolitical factors that can depress prices at any given moment.

One example is OPEC’s November 2020 decision to maintain production. The news sent oil prices crashing below $70 per barrel that day – a level not seen in over four years.

Natural gas prices, on the other hand, are much more stable. Trading is more localized since natural gas is harder to transport overseas.

Natural gas futures generally perform well during the harsh winter months. Prices rose above $3 in January and February when subzero temperatures blanketed most of the Eastern United States.

Henry Hub

What Is Henry Hub?

Henry Hub is a natural gas pipeline located in Erath, Louisiana, that serves as the official delivery location for futures contracts on the New York Mercantile Exchange (NYMEX). The hub is owned by Sabine Pipe Line LLC and has access to many of the major gas markets in the United States. The hub connects to four intrastate and nine interstate pipelines, including the Transcontinental, Acadian and Sabine pipelines.

Understanding Henry Hub

The Henry Hub pipeline is the pricing point for natural gas futures on the New York Mercantile Exchange. The NYMEX contract for deliveries at Henry Hub began trading in 1990 and is deliverable 18 months in the future. The settlement prices at Henry Hub are used as benchmarks for the entire North American natural gas market and parts of the global liquid natural gas (LNG) market.

Importance of Hub Pricing

Henry Hub is an important market clearing pricing concept because it is based on the actual supply and demand of natural gas as a stand-alone commodity. Other natural gas markets like Europe have fragmented hub pricing points. This means natural gas prices are often indexed to crude oil, which can have very different supply and demand factors affecting its price. Attempts are being made to develop European hub pricing points in the Netherlands and the UK, but this has proved difficult so far due to competition from national hubs. Asian natural gas markets are even more fragmented and have no defined hub pricing point, although Singapore would like to serve this regional role. Consequently, all Asian natural gas prices are either indexed to crude oil or linked to Henry Hub.

Henry Hub and Liquid Natural Gas

Henry Hub is also used in delivery contracts for LNG on a global basis, despite being a spot price for natural gas that is very specific to the North American gas market. Some global gas producers like Qatar and Australia prefer to base the pricing mechanism of their natural gas deliveries on spot prices rather than indexing to the price of oil. This is especially true when crude oil prices are falling. Gas producers can rely on Henry Hub as a source of natural gas spot pricing to meet this need because of its large trading volume, clear pricing transparency, and high liquidity. Henry Hub prices are widely quoted by futures exchanges and other media sources, so parties to a contact can easily obtain this pricing data.

Get Started Trading Futures

Ready to get started trading futures? Here are five steps we recommend you take first.

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1. Make Sure You Understand How Futures Contracts Work

Futures differ in important ways from stocks, ETFs and other instruments: trading in tick increments, margin levels, and so on. Be sure to understand how futures work.

2. Select a Few Markets You Want to Trade

Before trading, pick a market or two in which you’re interested. Understand the fundamentals behind prices. Watch and learn the markets by using our educational content, news, research and commentary.

3. Construct a Trade Plan

Before you enter a trade, first develop a plan to guide your decision-making process. Your plan should be based on careful analysis of the markets you intend to trade. Some questions to answer:

  • What is your objective for the trade?
  • How much risk is in the trade?
  • How much risk are you willing to accept?
  • What types of orders will you use?
  • How will you monitor market developments and price movements?

4. Practice Trading on a Simulator

Become familiar with the markets you plan to trade before you trade. One way is with an electronic trading simulator that replicates real-world trading conditions. It’s a good way to get familiar with price quotations, market terminology and the market’s general behavior.

5. Select a Broker and Establish a Futures Trading Account

In order to trade futures, you must open an account with a registered futures broker who will maintain your account and guarantee your trades. In the futures business, brokerage firms are known as either a futures commission merchant (FCM), or an introducing broker (IB).

Many securities brokers are also registered to deal in futures. You may want to see if your current broker can provide you with this service. Working with a knowledgeable broker and quality firm can play an important role in your long-term success.

Contact several brokers until you find the right combination of cost and service for your needs.

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