Natural Gas Futures Market

James TodaroFebruary 2001

Bangladesh Ministry of Energy and Mineral Resources

Jtodaro@eia.doe.gov

2

Presentation Objectiveswhat is... Futures Market/Contract Market Term(s) Pricing pattern(s) Whose in Natural Gas Futures Market Difference from Spot Market Worldwide Energy Futures Markets

3

Futures Market A location where trading (buy-sell) in

commodities is conducted in accordance with specific rules, procedures, and guarantees.

4

What is a Futures Contract?

It is a standardized contract for the purchase or sale of a commodity.

Traded for future delivery under provisions of

exchange regulations.

It specifies: the unit of sale, how it is quoted in dollars (or other currency)

5

Futures contract (cont’d.) Minimum and maximum fluctuations, when

and at what times traded

Where delivery is made and over what period

Penalties for failure to make delivery

6

Futures Contract Elements The futures contract must be tied to a

physical commodity which is fungible

The underlying commodity must be widely traded in free unregulated markets

Price variability/volatility must exist

7

Futures Contract Standards Contract guarantees…

Payment

Location

Quality

8

Daily Settlement Prices

Daily Near-Month Contract Settlement Prices

$0.00

$2.00

$4.00

$6.00

$8.00

$10.00

$12.00

Do

lla

rs

pe

r M

MB

tu

1998

1999

2000

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

9

Contract Specifications

NYMEX Natural Gas : 60 Consecutive Months Forward 10,000 MMBtu per Contract Delivery to the Henry Hub in

Louisiana No near-month daily limit

10

NYMEX Energy Futures Website (www.quotewatch.com/exchanges/nymex_cs)

Month2001

Open $ High $ Low $ Set’l/last

March 5.670 5.670 5.480 5.490

April 5.600 5.620 5.460 5.480

May 5.580 5.580 5.440 5.460

11

What Effects the Natural Gas Market...

Fundamentals Supply: production,

stocks, pipeline capacity, and location

Demand: weather, application or process

Seasonality: change of seasons, stock mgt.

Externals Legislation Environmental Areas OPEC News/Rumor New Technology

12

Natural Gas: 10 yrs. on NYMEXVolume Continues to Grow

Monthly Totals of Contracts Traded

0

500,000

1,000,000

1,500,000

2,000,000

2,500,000

Apr-

90

Jul-90

Oct-

90

Jan-9

1

Apr-

91

Jul-91

Oct-

91

Jan-9

2

Apr-

92

Jul-92

Oct-

92

Jan-9

3

Apr-

93

Jul-93

Oct-

93

Jan-9

4

Apr-

94

Jul-94

Oct-

94

Jan-9

5

Apr-

95

Jul-95

Oct-

95

Jan-9

6

Apr-

96

Jul-96

Oct-

96

Jan-9

7

Apr-

97

Jul-97

Oct-

97

Jan-9

8

Apr-

98

Jul-98

Oct-

98

Jan-9

9

Apr-

99

Jul-99

Oct-

99

Jan-0

0

Apr-

00

Jul-00

Oct-

00

Nu

mb

er

of

Co

ntr

acts

13

Futures Market Terms…

Near-Month:The futures contract closest to expiration-June will close in May

Settlement Price: Daily price the market settles all accounts on each month’s contract-usually the last price of the day

Bid: A price a member will pay for a contract.

14

Market Terms...

Long (position): A member who has bought futures contracts

Short(position): A member who has sold futures contracts

Offer: A price a member will sell a contract

15

Market Terms …Basis

Basis: The difference between the current spot price of natural gas and the futures price

Spot and Futures Prices

2

3

4

5

Mar Apr MayD

olla

rs p

er M

MB

tu

Spot FuturesBasis =$0.20

16

Market Terms…Strip Price

Strip Price: Average of the daily settlement price of the next 12 months futures contracts...

17

Strip Price Computed from the Reuters NYMEX Report

Month Price

March 6.158

April 5.861

May 5.642

June 5.612

July. etc 5.632

(2001)

18

More Market Terms... Forward Months: Future months or contracts

other than the near-month. (If Feb. is the near-month, Mar, Apr, and May are the forward months.)

Volume: The number of purchases and sales of a futures contract made during a specified period of time, often the total transactions for for one trading day.

19

Market Terms... Closing Price: The price at the end of trading on

the scheduled day that near-month contract expires-also called the last price.

Hedging: Offsetting the price risk present in a spot market position by taking the opposite position in the futures market.

20

Examples Using a Hedging Strategy

A natural gas producer sees Sept. Futures Mkt. price is $5.00 per MMBtu, he would like to sell and deliver gas in the spot Mkt. in Sept. at $5. In order to lock in the $5 selling price, the prod. will enter the Futures Mkt. obtaining a futures contract to sell gas in Sept. at $5. When trading on the Sept. futures contract closes, the prod. must offset (hedge) his position by obtaining a futures contract to buy gas at the Sept. closing price. Possible results...

21

Hedging Results: 1. Sept close is $5, spot Sept deliv is $5, prod gets desired result.

Market Sept Price Sell/Buy Gain/Loss

Spot 6.00 Sell +1.00

Futures 6.00 Buy -1.00

Spot 4.00 Sell -1.00

Futures 4.00 Buy +1.00

Other Results

22

Futures Market Pricing Patterns

Contango Pricing: A market situation in

which prices are progressively higher in the succeeding delivery months than in the nearest delivery month.

Contango Pricing Series

0

1

2

3

4

5

6

Aug Sept Oct Nov DecD

olla

rs p

er M

MB

tu

23

Futures Market Pricing Patterns Backwardation Pricing:

Is a market situation in which prices are progressively lower in the distant delivery months. (May also be called an “inverted market”).

Backwardation Pricing Series

0

1.5

3

4.5

6

Jan Feb Mar Apr MayD

olla

rs p

er M

MB

tu

24

Natural Gas Futures Contract Closes During Bidweek

When the bulk of trading may occur near the end of the month,e.g. March, 2001 contract closes on February 27.

Bidweek Near-Month Contracts,Sept to Dec 1999

0

50

100

150

200

250

Oct Nov Dec JanC

on

trac

ts in

1,0

00's

2nd wk 4th wk

25

Natural Gas Futures MarketParticipants Share in 2000

End Users0.9%

Gas Processors0.3%

L,D,C,s1.7%

Financial6.2%

Funds4.7%

Floor Trader6.1% Investors

3.1%

Marketers68.6%

Producers8.4%

2000

26

Marketers and Financials Dominated NYMEX Natural Gas Trading in 2000

With over 80% of trades last year, these groups continue to be the most active players in the NYMEX natural gas futures market. Who are they?

27

Natural Gas Futures Market Leaders... Marketer:Sells gas, transportation, and

storage services. Marketers buy gas at the wellhead and at markets or hubs for resale.

Financials:Investment funds and others that are in the market for short-term gains-rarely take delivery.

28

Other Market Participants who are they?

Producers:find and deliver the gas at the wellhead

End Users:the gas consumer Pipelines:carry gas to the end user LDC:local distrib co get gas to end-users Gas Plants:place where gas is prepped or

dried before entering pipeline system

29

Other Energy Futures Markets

30

Where are they located*?

*Markets Found on the Internet

31

Worldwide Energy Futures Markets*

United States: New York Mercantile Exchange (NYMEX)

UK: London International Petroleum Exchange (IPE)

Asia: Singapore Exchange-Derivatives Trading (SGX-DT)

Australia: Sydney Exchange (SFE)

*Results of Internet search

32

Energy Futures Contracts Traded

NYMEX Light Crude Oil Heating Oil Unleaded

Gasoline

•Natural Gas•Propane•Heavy Crude Oil•Electricity

33

Energy Products Traded IPE Brent Crude Oil Gasoil Unleaded

Gasoline Natural Gas

SGX-DT Crude Oil

SFE Electricity

34

Requirements and ProceduresSGX-DT (crude oil contract)

Months - 12, next Quarterly cycle, Mar,

June, Sept, Dec Close on the 15th $ Limits $15 No limit last day or

30 min. before close

Delivery per contract

Price set at IPE Cash payment

due prior to delivery

(www.simex.com/sg)

35

Natural Gas Futures Market Recap: Futures Market Requirements Market terminology Market participants Trading strategy - hedging Price connection w/spot (physical Mkt.) World Markets