Natural gas is a highly traded commodity known for its volatility, making it an attractive option for traders. Here, we will explore the basics of trading natural gas, factors that influence its price, and some useful strategies.
Basic Information on Natural Gas Trading
Natural gas is the second most utilised energy source for power generation, accounting for 22% of global power production in 2017. Its popularity has been driven by increased usage in developing countries like China and Indonesia over the past decade.
Natural gas serves various purposes, including heating buildings, water boilers, vehicle fuel, cooking, air conditioning, and industrial furnace power. Notably, the Henry Hub Natural Gas (NG) futures, traded through the Chicago Mercantile Exchange Group (CME Group), serve as the industry benchmark. Named after a natural gas pipeline in Louisiana, the Henry Hub is the official delivery location for futures contracts. In terms of volume, natural gas futures rank as the third-largest physical commodity futures contract worldwide.
Leading Producers of Natural Gas
As of September 2021, the United States, Russia, and Iran were the world's largest natural gas producers. Unlike oil, which is typically found in extensive underground reservoirs, natural gas is often trapped in rocks and sediment. To extract it, companies employ hydraulic fracturing, also known as fracking, involving the injection of water, chemicals, and sand deep into the earth to release the natural gas.
Factors Influencing Natural Gas Prices
Similar to most commodities, natural gas prices are influenced by the forces of supply and demand. Several key factors impact the supply and demand dynamics of natural gas, including stored reserves, global demand, alternative fuel development, alternative fuel prices, and weather conditions.
Supply and demand imbalances drive natural gas prices. If the demand for natural gas exceeds the supply, prices rise due to higher demand than available supply. Conversely, if the supply surpasses demand, prices decline.
Stored Reserves of Natural Gas: Countries maintain natural gas reserves to mitigate price increases during periods of reduced production. By using these reserves during supply shortages, countries can temporarily lower demand. However, when reserves become depleted or insufficient, countries must purchase more natural gas, leading to higher prices.
Global Demand: Global demand for natural gas has been steadily increasing, particularly in emerging Asian markets, and is expected to rise around 1.6% annually over the next five years. The United States remains the largest consumer of natural gas, followed by Russia, China, Iran, and Indonesia. The impact of rising global demand on prices depends on whether increased production can meet the growing demand.
Price of Alternative Energy Sources: If alternative fuels are more affordable than natural gas, the demand for natural gas decreases. This can occur when there is an oversupply of oil or when governments prioritize the development of nuclear power plants and wind farms, reducing the price of these alternative energy sources. Additionally, stricter regulations on hydraulic fracturing can limit natural gas extraction, causing prices to rise relative to other forms of energy.
Weather Conditions: Severe weather events such as hurricanes and storms can disrupt natural gas production for days or even weeks. Reduced supply leads to depleted reserves and higher prices. Similarly, colder winters can drive up natural gas demand as people increase heating in their homes, resulting in increased prices.
Natural Gas Trading Methods
Traders employ various methods to trade natural gas, including futures contracts, options, and contracts for difference (CFDs).
Futures Contracts: The most common approach is trading natural gas through futures contracts like the Henry Hub natural gas futures contract on the CME. Traders agree to deliver a specific amount of natural gas at a predetermined future date for an agreed-upon price. However, it's essential to note that traders
Some trading strategies for natural gas in contract for difference
Trading strategies for natural gas in Contract for Difference (CFD) involve taking advantage of price movements in the natural gas market. Here are a few strategies commonly used by traders:
Trend Trading: This strategy involves identifying the prevailing trend in the natural gas market and trading in the direction of that trend. Traders may use technical analysis tools, such as moving averages or trendlines, to determine the trend. If the trend is upward, they would look for buying opportunities, and if the trend is downward, they would seek selling opportunities.
Breakout Trading: Breakout trading involves identifying key levels of support and resistance on the natural gas price chart. Traders would wait for a significant breakout above resistance or below support levels, indicating a potential trend continuation or reversal. They would enter trades in the direction of the breakout, anticipating further price movement.
Range Trading: Range trading is suitable when natural gas prices are trading within a defined range or channel. Traders identify the upper and lower boundaries of the range and place trades accordingly. They would buy near the support level and sell near the resistance level, taking advantage of price oscillations within the range.
Seasonal Trading: Natural gas prices are influenced by seasonal factors, such as weather conditions and demand patterns. Traders employing this strategy analyse historical data to identify recurring seasonal trends. For example, they may observe that natural gas demand tends to increase during winter months and plan their trades accordingly, anticipating higher prices.
Fundamental Analysis: Traders using fundamental analysis focus on economic, geopolitical, and supply-demand factors that influence natural gas prices. They analyse factors such as production levels, inventories, weather forecasts, political events, and economic indicators to assess the market's fundamental conditions. Based on this analysis, they make trading decisions.
Spread Trading: Spread trading involves taking positions in two related natural gas contracts simultaneously to profit from price differentials between them. For example, a trader may buy natural gas in one contract while simultaneously selling natural gas in another contract, anticipating the price difference between the two contracts to converge or diverge.
It's important to note that trading CFDs involves risks, including the potential for losses. It's recommended to develop a solid understanding of these strategies and to consider risk management techniques such as setting stop-loss orders and using proper position sizing. Additionally, traders should stay updated with market news and developments that could impact natural gas prices.