Natural Gas Futures Market James Todaro February 2001

Natural Gas Futures Market James Todaro February 2001 Bangladesh Ministry of Energy and Mineral Resources Jtodaro@eia. doe. gov

Presentation Objectives what is. . . n n n Futures Market/Contract Market Term(s) Pricing pattern(s) Whose in Natural Gas Futures Market Difference from Spot Market Worldwide Energy Futures Markets 2

Futures Market n A location where trading (buy-sell) in commodities is conducted in accordance with specific rules, procedures, and guarantees. 3

What is a Futures Contract? n It is a standardized contract for the purchase or sale of a commodity. n n n Traded for future delivery under provisions of exchange regulations. It specifies: the unit of sale, how it is quoted in dollars (or other currency) 4

Futures contract (cont’d. ) n Minimum and maximum fluctuations, when and at what times traded n Where delivery is made and over what period n Penalties for failure to make delivery 5

Futures Contract Elements n n n 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 6

Futures Contract Standards n Contract guarantees… n Payment n Location n Quality 7

Daily Settlement Prices 8

Contract Specifications n NYMEX Natural Gas : 60 Consecutive Months Forward n 10, 000 MMBtu per Contract n Delivery to the Henry Hub in Louisiana n No near-month daily limit n 9

NYMEX Energy Futures Website (www. quotewatch. com/exchanges/nymex_cs) 10

What Effects the Natural Gas Market. . . n 8 8 8 Fundamentals n Supply: production, stocks, pipeline capacity, and location Demand: weather, application or process Seasonality: change of seasons, stock mgt. 8 8 8 Externals Legislation Environmental Areas OPEC News/Rumor New Technology 11

Natural Gas: 10 yrs. on NYMEX Volume Continues to Grow 12

Futures Market Terms… n Near-Month: The futures contract closest to expiration-June will close in May n Settlement Price: Daily price the market settles all accounts on each month’s contractusually the last price of the day n Bid: A price a member will pay for a contract. 13

Market Terms. . . n Long (position): A member who has bought futures contracts n Short(position): A member who has sold futures contracts n Offer: A price a member will sell a contract 14

Market Terms …Basis n Basis: The difference between the current spot price of natural gas and the futures price 15

Market Terms…Strip Price n Strip Price: Average of the daily settlement price of the next 12 months futures contracts. . . 16

Strip Price Computed from the Reuters NYMEX Report Month (2001) Price March 6. 158 April 5. 861 May 5. 642 June 5. 612 July. etc 5. 632 17

More Market Terms. . . n n Forward Months: Future months or contracts other than the near-month. (If Feb. is the nearmonth, 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 one trading day. 18

Market Terms. . . n n 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. 19

Examples Using a Hedging Strategy n 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 20 results. . .

Hedging Results: 1. Sept close is $5, spot Sept deliv is $5, prod gets desired result. Other Results 21

Futures Market Pricing Patterns n n Contango Pricing: A market situation in which prices are progressively higher in the succeeding delivery months than in the nearest delivery month. 22

Futures Market Pricing Patterns n Backwardation Pricing: Is a market situation in which prices are progressively lower in the distant delivery months. (May also be called an “inverted market”). 23

Natural Gas Futures Contract Closes During Bidweek n When the bulk of trading may occur near the end of the month, e. g. March, 2001 contract closes on February 27. 24

Natural Gas Futures Market Participants Share in 2000 25

Marketers and Financials Dominated NYMEX Natural Gas Trading in 2000 n 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? 26

Natural Gas Futures Market Leaders. . . n n 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. 27

Other Market Participants who are they? n n n 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 28

Other Energy Futures Markets 29

Where are they located*? *Markets Found on the Internet 30

Worldwide Energy Futures Markets* n n 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 31

Energy Futures Contracts Traded n n NYMEX Light Crude Oil Heating Oil Unleaded Gasoline • Natural Gas • Propane • Heavy Crude Oil • Electricity 32

Energy Products Traded n n n IPE Brent Crude Oil Gasoil Unleaded Gasoline Natural Gas n SGX-DT n Crude Oil n SFE n Electricity 33

Requirements and Procedures SGX-DT (crude oil contract) n n n Months - 12, next Quarterly cycle, Mar, June, Sept, Dec Close on the 15 th $ Limits $15 No limit last day or 30 min. before close n n n Delivery per contract Price set at IPE Cash payment due prior to delivery (www. simex. com/sg) 34

Natural Gas Futures Market Recap: n n n Futures Market Requirements Market terminology Market participants Trading strategy - hedging Price connection w/spot (physical Mkt. ) World Markets 35