Buying Natural Gas Call Options to Profit from a Rise in Natural Gas Prices

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Trading natural gas in 2020: your ultimate guide to a naturally occurring commodity

What is natural gas?

Natural gas, also known as fossil gas, is a naturally occurring energy source that is formed deep beneath the earth’s surface. It contains many different components, however, the largest constituent is methane. Colourless and odourless in its natural state, natural gas is the cleanest burning fossil fuel available today: when it’s burned, it produces mostly carbon dioxide, water vapour and minor amounts of nitrogen oxides.

The formation of natural gas began millions of years ago. The remains of dead plants and animals decayed, forming thick layers of organic material mixed with silt and sand. Over time, more deposits of rock and sand covered this substance and buried it deep beneath the ground. Heat and pressure then transformed this organic matter into the fossil fuels we use today. Some of it evolved into petroleum, some transformed into coal and some evolved into natural gas.

Just like other forms of heat energy, natural gas is measured in British thermal units (Btu). Accessible and abundant resources, technological developments and the world’s extensive delivery infrastructure have created a fundamental shift in the natural gas marketplace, providing an opportunity to satisfy significantly growing demand at rather affordable prices.

The largest countries worldwide are involved in the extraction and processing of hundreds of billions of cubic meters of natural gas yearly.

What makes it so valuable?

The popularity of natural gas has been maintained by its increased use in rapidly developing countries, such as Indonesia and China. As the global community looks to diversify its energy mix, the importance of natural gas is continuously growing. While it is not as clean as wind or solar energy, it remains the cleanest fossil fuel energy source available today. It produces about half less than oil and a third less carbon dioxide than coal when burned. It also emits little to no sulfur, making it more eco-friendly and efficient than others.

What are the applications of this commodity? In fact, you might find it surrounding you daily: it fuels your vehicle, heats your house, dries your laundry, operates refrigeration and cooling equipment, cooks food and provides outdoor lighting.

Natural gas plays a crucial role in producing electricity and serves as a source of fuel for homes, industries and governments.

What drives the price of natural gas?

As a matter of fact, the sources of natural gas are limited, and it takes time to find, develop, explore and drill new ones. In recent years, prices for natural gas have been strongly correlated with its production: when production increases, consumer prices fall, while declines in production results in higher prices.

However, that is not the only aspect that has an impact on the natural gas price. The following factors can lead to the largest price swings:

  • Economic growth. Increased economic growth, especially in the industrial sector, tends to push up the price of natural gas as demand rises for consumables and services provided.
  • Weather. Abnormal or extreme weather can have a big impact on the prices of natural gas, pushing and pulling on the supply and demand forces. Typically, unforeseen changes in weather can have the biggest effect, especially when natural gas is in shortage and pipelines are transporting at full capacity.
  • Supply. The supply of natural gas in storage affects the price, depending on whether there is a deficit or surplus. If there is a surplus, then prices are likely to go down due to an abundant supply, and vice versa.
  • Substitutes. Alternative products, especially more eco-friendly sources of energy, such as wind, solar and hydroelectric power, also affect natural gas prices. With an increased focus on “going green”, these environmentally friendly substitutes may become strong competitors of natural gas in the future. Additionally, some large fuel consumers, like electric power plants, can substitute between natural gas, petroleum and coal, depending on the price of each.

What are the advantages of adding natural gas to your portfolio?

First of all, as it is priced in US dollars, natural gas investing can be a way to bet on a weak currency performance and higher inflation. Once the US dollar shows some inflation concerns, the price of the commodity might benefit from fears due to its limited supply.

Another great reason to invest in natural gas is diversification. If you are looking for a way to hedge the risks, then you should consider adding a portion of commodities, such as natural gas, oil and metals, to your investments list. Investing in commodities is one of the ways to create a winning portfolio.

What do the experts say about natural gas?

Global demand for natural gas has largely been on the rise for the last decade. According to the International Energy Agency, it is expected that in the next five years demand for natural gas will rise by around 1.6% a year, with the majority of this growth coming from emerging Asian markets.

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Today, many energy companies see natural gas as a key driver of future growth. Patrick Pouyanne, the CEO of Total SAA, one of the world’s largest energy companies, describes natural gas as “the fossil fuel of the future”, saying that in 35 years Total will produce and distribute more gas than oil.

More than half of Shell’s production is attributable to natural gas. The commodity is also a growing segment of Chevron’s energy portfolio, and the group says it has “the capabilities required to develop resources and deliver natural gas to markets where its use is growing.”

BP, a British multinational oil and gas company, plans on lower-for-longer oil prices and shift towards gas in its portfolio as part of its business strategy. Meanwhile, ExxonMobil, an American multinational oil and gas corporation, believes natural gas is “a major game changer with fewer emissions, flexibility and abundance.”

So, should you trade natural gas in 2020?

Like any other commodity, natural gas prices may be highly volatile. These price swings attract many day traders from all around the world since the spread is rather reasonable, offering high liquidity and making it easy for traders to get in and out of trades. Exposure to natural gas is not only accessible through the commodity itself, but also through a plethora of exchange-traded funds (ETFs) and contracts for difference (CFDs).

However, when trading natural gas, you should also consider the risks:

Higher natural gas prices or lower costs for other green energy resources could lead consumers to substitute consumption;

Global political or economic uncertainty could strengthen the US dollar and weaken demand for commodities;

A global recession could weaken energy demand.

How to start trading natural gas in 2020

If you are wondering how to trade natural gas, there are actually several ways you can get your hands on the commodity. You can invest in natural gas exchange-traded funds (ETFs) or trade stocks that have a vested interest in the related industry, such as Gazprom, BP or Royal Dutch Shell.

However, one of the easiest ways to start trading natural gas is through contracts for difference (CFDs). CFD allows you to go short or long on the asset without ever taking ownership of it. Therefore, you simply speculate on its price direction in order to profit from the price difference: if you think the price will rise, you ‘Buy’; if you think the price will fall, you ‘Sell’.

A contract for difference provides easier execution and greater liquidity, as well as allows trading on margin, offering bigger exposure to the chosen markets. However, as CFDs are a leveraged product, gains, as well as losses, are magnified.

You can learn more about CFD trading with free online courses provided by Capital.com.

Natural gas trading strategies

Trading natural gas involves similar strategies used to trade other commodities, such as gold, orange juice or crude oil. Capital.com offers a comprehensive guide to natural gas trading, as well as provides various trading strategies examples.

Bookmark our economic calendar to stay informed of upcoming events, which could influence natural gas prices and stay up to date with live Natural Gas price, using our live chart and latest news.

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Weekend Investor

Drilling for profit in natural gas

Shawn Langlois

Protect you pocket this heating season with right stocks

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SAN FRANCISCO (CBS.MW) — With Old Man Winter looming and a chill breeze starting to blow, heating bills are about to take their annual pilgrimage to wallet-squeezing territory.

But the added expense needn’t put the freeze on your financials.

In fact, investing in the wide range of companies that profit from rising gas prices and increased demand can help to diversify and warm your tepid portfolio.

“For my money, I’d take a hard look at investing in the natural gas sector,” said Martin Twist, chief operating officer of Cherokee Energy. “If we end up having a cold winter, we’re going to see prices continue on the upward trend.”

The price of natural gas, a fuel that’s growing more and more popular in heating homes and powering industrial plants, is directly affected by the demand created from temperature fluctuations.

The Energy Information Administration forecasts that household winter heating fuel supplies should be sufficient to avoid the major price spikes of last winter.

The agency predicts natural gas prices to average about $4.30 per thousand cubic feet, down from $4.60 last year, with demand declining 2.4 percent. Inventories have moved into historically normal ranges after months of strong buildup.

At this point, the National Weather Service sees a warmer-than-usual trend in the Western United States while the rest of the nation has an “equal chance of above, below and normal temperatures.”

The Old Farmer’s Almanac, on the other hand, calls for colder-than-average temperatures in the East.

Mild winter or not, Twist believes that we’ll continue to see an extended run of rising gas prices.

“We still have lots of trouble in the Middle East, lingering effects from the lights out up in the Eastern Seaboard, the problems out West in the past couple years,” Twist said. “We really don’t have a solid energy policy,”

A good run

Stocks in the natural gas arena have enjoyed remarkable returns this year as last winter’s frigid temperatures had companies scurrying to maintain ample supply, even as prices surged.

The Amex Natural Gas Index XNG, +6.14% tracks the most prominent issues in the sector and has risen 51 points, or 35 percent, to 197 since the beginning of the year. Every single component in the group has registered positive performances with the exception of Anadarko Petroleum APC, -1.04% , which has slipped almost 14 percent.

Power and gas seller Dynegy DYN, -2.16% topped the index’s leading percentage gainers, more than tripling from the $1-level. Still that’s well below its $60 highs hit in 2000 before an alleged scheme to book debt as cash flow sent investors scurrying.

Some experts are concerned that the high natural gas prices aren’t sustainable, potentially putting the pinch on the thriving group.

“If you’re worried that prices, a fundamental driver for these businesses, can only come down from here, then that should be enough to keep you away from these stocks,” said Langdon Healy, analyst at research firm Morningstar.

But he believes that the sector’s fundamentals, particularly over the long term, remain strong.

“Natural gas has become the fuel of choice — it’s much cleaner burning than other fuels and a lot of electrical power plants have turned to it as a fuel source rather than coal or oil,” he said. “It’s a rather positive scenario for the industry.”

How to play it

Perhaps the safest way to gain exposure to the sector would be to allocate a small percentage of your portfolio to a mutual fund focused on natural gas companies.

Healy pointed out three in particular that might be worth a look.

  • State Street Research Global Resources SSGRX, -0.62% has returned in excess of 35 percent this year, more than doubling the performance of the S&P 500. Western Gas Resources WG.R, makes up more than 7 percent of the fund’s portfolio.
  • Fidelity Select Natural Gas FSNGX, +4.40% hasn’t fared nearly as well, up about 12 percent, but the fund offers concentrated exposure to the sector. Oil and gas exploration/production company Apache APA, +16.25% is by far the largest holding and has risen by nearly one-third year-to-date.
  • Invesco Energy FSTEX, +5.45% covers a wide range of energy companies with a focus on the midcap area. The fund has gained 8 percent so far.

On individual positions, Raymond Deacon, principal at First Albany, tapped his top picks in the sector earlier this month, including Devon Energy DVN, +8.03% , Penn Virginia Resources, Tom Brown TBI, +3.97% , Denbury Resources DNR, +3.18% and Western Gas Resources WG.R, .

“We continue to favor companies leveraged to natural gas that have demonstrated discipline in capital allocation, superior technical, and operating competencies, and have an abundance of attractive low risk, high rate of return projects,” he wrote in the report.

Deutsche Bank’s John Edwards issued a report in which he maintained a bullish stance on the pipeline and exploration/production area but turned cautious on the distributors.

Kinder Morgan KMI, +4.43% is Edwards’ top pick. Shares of the pipeline partnership have already pumped up by nearly a third and last week the company said it expects to increase its dividend by at least 25 percent in 2004.

Currently, Kinder Morgan stock yields over 3 percent.

From the distributor segment, he mentioned Equitable Resources EQT, +0.83% as having the “best visible growth opportunities.”

“We remain positive on the sector as a whole,” he wrote. “But while it sounds cliché, we believe the easy money has been made. Sector multiples have recovered significantly since they collapsed following the Enron and energy marketing debacle.”

As with most investments, assessing risk is key, especially when it comes to playing individual stocks in a volatile area like energy.

“Some people say oil and gas is a big gamble. Well, the entire stock market is the real gamble,” said Twist. “But what are you going to do? Put all your money in a CD?”

“Come on, that just doesn’t make any sense.”

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Natural Gas May ’20 (NGK20)

Natural Gas Futures Market News and Commentary

May Nymex natural gas (NGK20) on Wednesday closed down -0.69 (-3.73%).

Nat-gas prices on Wednesday posted moderate losses on demand concerns as the global economy remains in partial lockdown from the coronavirus pandemic, which has decimated energy demand.

U.S. nat-gas demand has weakened due to the pandemic with U.S. nat-gas consumption last week averaging only 73.1 bcf per day, down -7.9% from the previous week.

A report from researcher ICIS said China’s 2020 LNG imports may fall -5.2% y/y to 58.1 MT due to demand destruction cause by the coronavirus outbreak.

Nat-gas prices slid into the close Wednesday on the outlook for an above-average gain in weekly nat-gas supplies. The consensus is for Thursday’s weekly nat-gas inventories to climb by +28 bcf, well above the 5-year average rise of +6 bcf.

May nat-gas on Tuesday rallied to a 3-week high on forecasts for colder U.S. temperatures. Maxar on Tuesday said temperatures may be below normal across. Read more

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