How to trade natural gas

How to trade natural gas 

Because natural gas is used to generate more than 20% of the world’s power supplies, it has become a popular commodity to invest in and trade. Like all natural assets traded on the financial markets, the price of natural gas fluctuates. Moreover, futures contracts are set by a benchmark standard. That standard is the Henry Hub Natural Gas (NG). This industry benchmark for natural gas sets the market’s tone. In other words, it’s the reference point from which all natural gas trades are based. 

As such, the most common way to invest in and trade natural gas is through futures contracts. Futures trading involves a legal agreement to buy or sell something at a predetermined date in the future. In this instance, you can buy natural gas contracts that you agree to “buy” or “sell” at a set price on a specific date. 

You can buy or sell because these contracts allow you to take both sides of the proverbial coin. In other words, you can buy and take a long position, which means you believe the value of the asset (i.e. gas) will increase. Therefore, you’re going to commit to buying at the current price because you believe it will go up, allowing you to offload the contract at a profit. 

Alternatively, futures contracts give you the ability to sell, which means you’re taking a short position. In simple terms, a short position means you believe the value of an asset will decrease. Therefore, you’re saying you want to sell it at a later date but at the current price (i.e. what you believe will be a higher price). 

Because futures contracts are a financial derivative, you’re expected to buy all or a percentage of the underlying asset. A derivative is a financial contract that derives its value from something else which, in this case, is gas. Therefore, you have the flexibility to trade a contract that’s worth some or all of one standard unit of the underlying asset’s value. 

Examples: buying and selling natural gas futures 

This is where traders can use leverage to secure a long or short position. Whichever position you decide to take, the key point to note here is that natural gas futures require you to “buy” or “sell” contracts at a point in the future. 

So, let’s say you take a “long” position. This means you’re agreeing to pay the market price at the time of executing the contract (i.e. making the trade) an agreed amount for gas on a set date. Natural gas futures contracts are measured in batches of 10,000 million British thermal units (MMBtu). 

For this example, let’s say the current price is $50.00 per MMBtu. If you take a long position and the price of gas is $100.00 on the date you agreed to buy, you’d make a profit. Why? Because you locked in a contract at $50.00. This means you get to buy a MMBtu at $50.00, regardless of the actual price of gas when your futures contract expires. 

So, when you take a long position, you believe the commodity is going to appreciate in value before the contract expires (i.e. the time comes for you to sell). If you felt the price of natural gas was going to decrease, you could take a short position. This means you’re going to sell at the current price. If the current price is $50.00 and the price of natural gas dropped to $25.00, you’d still get to sell for the higher price you’d previously bought at. 

Of course, like all financial investments, it’s possible to lose money. If you take a long position and the price of gas decreases, you’ll pay more than the market rate. Conversely, if you take a short position and the price increases, you’ll be selling an undervalued product. 

What factors influence the price of natural gas? 

Natural gas is extracted from beneath the earth’s surface through a process known as fracking. The US is the largest producer and consumer of natural gas, followed by Russia. Therefore, political and economic events within these two countries can affect the price of natural gas. 

Of course, the same logic applies whenever major events happen in any country. However, because the US and Russia are the two leading nations with regard to natural gas, their economic and political events have a greater impact on the market. Other factors that can affect the trading price of natural gas are: 

• Supply and demand 
• Stored reserves – when usage drops, gas stores can increase which means the supply will outweigh demand and vice versa 
• Weather – any unprecedented weather extreme can disrupt gas production and supply chains 
• Alternative energy sources – the development and availability of alternative energy supplies, including cheaper fuels and renewables can impact the price of gas 

Best ways to invest in natural gas 

Futures contracts are a common way to take a position on natural gas, but they’re not the only way. As we explained, futures contracts are a type of derivatives trading. Therefore, you’re investing in the underlying asset i.e. natural gas. However, you can invest in gas without actually owning a unit of it by doing these types of trade: 

Natural gas stocks 

You can gain exposure to the market by investing in companies that have a direct interest in natural gas. For example, BHP Billiton and Enterprise Products Partners are large mining and energy companies. Buying stocks in either will give you exposure to the market because the value of these companies will rise, and fall based on the price of gas. 

However, it’s important to note that they don’t just deal in gas. Therefore, the value of stocks isn’t solely dependent on the price of gas. What’s more, by investing in these companies, you’ll also be getting exposure to other markets, such as oil and metals. 

Natural gas ETFs 

In the same way that you can get exposure to the natural gas market through stocks, you can invest in a basket of securities that has links to the industry. As you’ll see in our guide to ETFs, these financial products allow you to speculate on a variety of companies/instruments with a single investment. 

Natural gas CFDs 

Another way to trade natural gas is via CFDs. A contract for difference (CFD) allows you to speculate on the price movements of an asset. However, you don’t have to purchase the underlying asset. This means you can go long or short. Moreover, you may not need to use leverage in the same way you would with futures. 

The natural gas market has a high degree of liquidity. That means there are plenty of trading opportunities. That doesn’t mean it’s always going to be profitable or that you should enter the market. However, if you’re looking for something to trade, it could be a viable option.