How to trade natural gas

Natural gas trading basics

Natural gas is currently the second most used form of energy to generate power, representing 22% of globally generated power in 2017.¹ The popularity of natural gas has been maintained by its increased use in developing countries like China and Indonesia for the last decade or so.

Natural gas is used to heat buildings, boil water, fuel vehicles, cook food, run air conditioning units and power industrial furnaces. Household appliances like a gas hob or a house’s radiators function by turning the energy supplied by natural gas into heat.

Henry Hub Natural Gas (NG) futures are the industry benchmark and they are traded through the Chicago Mercantile Exchange Group (CME Group). The name comes from the Henry Hub, a natural gas pipeline in Louisiana which serves as the official delivery location for futures contracts. By volume, natural gas futures are the third largest physical commodity futures contract in the world.²

World’s biggest producers of natural gas

Unlike oil, which can be found in vast reservoirs beneath the earth’s surface, natural gas is often locked in rocks and sediment. To get it out, extraction companies will usually use a process known as hydraulic fracturing, or fracking, in which water, chemicals and sand are forced deep into the earth to drive the natural gas out.

Currently, the US leads the way in the fracking industry, producing 734.5 billion cubic metres of natural gas in 2017.

What moves the price of natural gas?

As with most commodities, the price of natural gas is driven by supply and demand. Some of the key factors affecting supply and demand for natural gas are the stored reserves, global demand, development of alternative fuels, prices of alternative fuels and the weather.

Essentially, if more people want to buy natural gas than sell it, the price will rise because it is more sought-after (the ‘demand’ outstrips the ‘supply’). On the other hand, if supply is greater than demand, the price will fall.

Stored reserves of natural gas

Many countries around the world have stores of natural gas which they can use in the event of a supply glut. By storing natural gas, governments hope to alleviate some of the problems associated with increased prices in times of reduced production.

By keeping stores of natural gas, countries will not need to buy as much during a supply shortage, which would keep demand low for a brief period. However, once a country’s reserves run out or run low, they will need to buy more which in the case of a shortage, means higher prices in lieu of reduced availability of natural gas.

Global demand

Global demand for natural gas has largely been on the rise for the past decade. In the next five years, demand for natural gas is forecast to rise by around 1.6% a year – with the majority of this rising demand coming from emerging Asian markets.⁴

That being said, the US is still the top consumer of natural gas in the world, followed by Russia, China, Iran and Indonesia. What effect an increasing global demand for natural gas will have on prices remains to be seen. If increased production from Qatar and America can satisfy the rising demand, prices may not be too drastically affected.

Development of alternative power

The development of greener alternatives to fossil fuels could cause the price of natural gas to drop. However, it is thought that in the coming years, the global population will become less reliant on fossil fuels like natural gas.

Evidence shows that global consumption of renewable energy has grown year on year, from 107 million tonnes oil equivalent in 2007 to 486.8 million tonnes oil equivalent in 2017.

Price of alternative forms of energy

If other fuels are cheaper to buy than natural gas, demand for natural gas will fall. This could happen if oil is being overproduced, or if governments dedicate more resources to building nuclear power plants and wind farms – which would reduce the price of these alternative forms of energy.

Equally, if government regulations place greater restrictions on hydraulic fracturing, it is likely that less natural gas will be extracted. Therefore, the price will increase relative to the price of other forms of energy generation such as renewable energy or nuclear power. A number of countries including Ireland, Germany, Australia, Scotland and Uruguay have already permanently or temporarily banned fracking in light of public opposition.

Weather

Severe weather, such as hurricanes and storms, can shut down natural gas production hubs for days or even weeks at a time. This means that reserves will run low as supply gets used up, which would cause the price to increase.

Equally, particularly cold winter weather could lead to more people increasing the heat in their homes. This would mean that more natural gas was being used to satisfy an increased demand which would cause its price to increase

Ways to trade natural gas

1. Future contracts
2. Options
3. Contracts for difference

Futures contracts

The most common way that traders take a position on natural gas is with a futures contract, such as the Henry Hub natural gas futures contract on the CME. With a futures contract, traders agree to the delivery of a certain amount of natural gas at a set date in the future for an agreed-upon price. However, this does mean that the trader may have to eventually take delivery of the asset.

With IG, you can speculate on the price of a futures contract – without taking ownership of the underlying asset – with a CFD.

Options

Aside from futures, traders can use options to speculate on the price of natural gas. There are two types of options, puts and calls , both of which give traders the right but not the obligation to buy or sell an underlying asset before a certain expiry date.

Contracts for difference (CFD)

CFDs enable you to speculate on the price movements of natural gas without taking any physical ownership of the underlying. With a CFD, you agree to exchange the difference in price from when you opened the contract, to when you close it.

CFDs can act as an effective hedge for your other active positions as they enable you to go short or long , meaning you can benefit from markets that are falling as well as rising.

Learn more about CFD trading.

Natural gas trading strategies

Prices for commodities that are a source of energy, such as natural gas or oil, have historically been volatile because of the numerous factors that can affect their supply and demand levels. As a result, the best trading strategies to use during your time on the natural gas market are ones which capitalise on small-time gains such as day trading – as the price can shift against you overnight in a long-term position.

• Day trading strategy
• Range trading strategy
• Breakout trading strategy

Day trading strategy

Day trading can be a viable way to speculate on the price of natural gas due to the high volatility in the market. Traders who deploy a day trading strategy seek to make small profits on a lot of trades throughout the day, meaning they are constantly scanning the markets throughout a single trading session.

As a result, a day trading strategy is best employed by individuals who have a lot of time to commit to the markets and who can dedicate their attention to news stories and other events that could affect the price of natural gas.

Range trading strategy

In a range trading strategy, a trader will identify levels of support and resistance in an asset’s price movements and seek to buy at levels of support and sell at levels of resistance . Range strategies work best in markets with lots of price movements where there isn’t a particular long-term trend.

This makes it a feasible strategy to use on the natural gas market, assuming that traders know how to accurately identify levels of support and resistance.

Discover how to identify levels of support and resistance .

Breakout trading strategy

Breakout trading is another effective strategy to use in highly volatile markets. Its success relies on a trader spotting a price increase in the early stages of that trend. As a result, a trader will buy low and sell high, after the assets price has ‘broken’ above a level of historical resistance.

Breakout traders can also enter a short position when the price of an asset ‘breaks’ below a historical level of support; meaning that a breakout trading strategy can be used in both rising and falling markets.

Natural gas trading hours

* Hours are set by CME Group and may vary. Hours will shift between March and November as the UK and US change to and from daylight savings on different days

5 steps to trading natural gas

1. Learn how CFDs work
2. Create an account and deposit your funds
3. Analyse supply and demand factors in the natural gas market
4. Choose the trading strategy that works best for you
5. Open, monitor and close your first position

Sources:

1. Enerda, 2018
2. CME, 2019
3. BP, 2017
4. IEA, 2018