Energy futures are among the most liquid and widely-traded markets worldwide. Considering the rising global population and the natural increase in its energy demands, this field is poised to grow even further. Today, the energy futures market is more developed and diverse than ever. It is considered a highly-lucrative niche for many market participants, including many short-term traders and long-term investors. This guide covers everything you need to know about energy futures trading, including a list of the most traded energy futures contracts and tips and tricks on how to successfully navigate this market.
Energy futures are derivative contracts with energy products as the underlying asset. Market participants can buy and sell energy commodities through energy futures at a predetermined future price and date.
The most popular types of energy futures are based on commodities like crude oil, natural gas, and electricity. Supply and demand are a prominent component of their price. However, unlike other commodities, they are more sensitive to geopolitical events.
Energy futures allow investors to speculate or ensure an efficient hedge against price fluctuations or external risks that may affect the underlying commodity. For example, an investment firm with a significant portfolio of oil and gas stocks would make sure to hedge its exposure by purchasing derivatives that would increase in value if the price of these commodities declines.
Other companies who trade energy futures include those who want to lock-in prices beforehand to ensure optimal industrial production planning and smooth operational processes. For example, suppose a company needs vast oil resources to power its production plant. In that case, it will try to ensure the required amount at the best possible price way before the actual purchase occurs. That way, if the price of oil suddenly goes up during the year, the company will not suffer from any unexpected increase in its production costs.
Compared to other commodities, energy futures have a relatively short history. They were first introduced in the 1970s out of the necessity to help control the price volatility in the underlying commodities and add an additional risk management tool to the arsenal of traders, investors, and end-users. Over time, energy futures managed to become an integral part of the modern financial system due to their efficiency in keeping prices in check.
You can find the complete list of energy futures contracts traded on CME here.
Energy Futures Trading vs. Other Derivatives
A derivative is a financial instrument that derives its value from the underlying asset. In the case of energy commodities, these can be natural gas, crude oil, coal, etc.
We can divide energy derivatives depending on where they trade at. The traditional exchange-traded energy derivatives include futures and options. Another more exotic category of energy derivatives is over-the-counter (OTC) swaps and forwards.
Energy derivatives are popular among all types of market participants. These include large production companies, utilities, energy producers, energy retailers, trading houses, investment firms, asset managers, and other financial institutions.
The extensive array of energy derivatives gives market participants a wide range of options to choose from. Because these contracts are very different from each other, they have different uses.
Key distinguishing factors between energy derivatives.
Financial contracts obligating the buyer to buy and the seller to sell an asset at a predetermined price and date
An agreement between parties to buy and sell an underlying asset at a specified future date and at an agreed rate
Financial contracts giving the right to buy or sell a contract at a predetermined price within a specified period
A contract upon which parties agree to exchange cash flows on a future date (a floating/market price is exchanged for a fixed price over a specified period of time).
No counterparty risk since payment is guaranteed by the clearinghouse
Credit default risk since it is privately negotiated and fully dependent on the counterparty for payment
The amount is usually restricted to the option premium paid.
As you trade with a counterpart, you bear the risk of their capacity to pay you the amount that may be due at settlement
Exchange or OTC
On and off exchanges
Where Are Energy Futures Traded?
You can engage in energy futures trading either on a formal exchange or over-the-counter (OTC).
The most popular market for energy futures is the Chicago Mercantile Exchange (CME) and, more specifically, the New York Mercantile Exchange (NYMEX). NYMEX is a part of the CME Group, which specializes in energy commodities trading. Other popular trading venues are Tokyo TOCOM and the Intercontinental Exchange (ICE).
When trading on those markets, traders input their orders into a central clearinghouse that matches buyers and sellers. The system is fully automatic. It can clear huge volumes of transactions at high speeds and almost no lag.
Aside from the regulated markets, it is possible to also trade energy futures over-the-counter (OTC). To do that, the trader relies on a counterparty to handle the process. These are usually qualified financial intermediaries such as an investment firm or a brokerage company.
Retail traders can buy and sell energy futures through the platforms of basically every broker out there. Thanks to their high liquidity, energy futures are a widely-spread instrument supported by all financial service providers.
What Are The Most Traded Energy Futures?
The best way to nail down the most liquid energy futures is by taking a look at the underlying commodities.
Crude oil is the king of all commodities. It is present in many aspects of our everyday lives. The plastic of your mobile phone, the detergent in your bathroom, the fuel in your car, the make-up and cosmetics in the closet – oil is used everywhere. The commodity is always in high demand due to how essential it is, which benefits its price.
The crude oil futures contract (CL) is the fourth most-traded futures instrument worldwide. The list with the top 5 most traded futures on the CME is the sole commodity among a group of futures with equities and interest rates as the underlying assets.
However, crude oil isn’t a uniform product. There are different types of crude oil, depending on the raw material’s specific characteristics, including sulfur content, the field of origin, and gravity. That is why there are crude oil futures contracts with different names, including Brent, West Texas Intermediate (WTI), Edmonton Light Sweet, Hardisty Western Canadian, and more.
The most popular crude oil futures: CL, BZ, and QM
Natural gas is considered a domestic commodity for the U.S. market. The majority of the traded instruments’ price depends on the production results and development of local sites. Among the states leading the production of natural gas are Texas, Alaska, Oklahoma, Pennsylvania, and Louisiana. The evaluation of the commodity is based on distinguishing characteristics like volume and heating quality.
Usually, natural gas remains in the list of the top 10 most actively-traded futures on the CME throughout the whole year. However, its demand peaks over the winter and the summer when the population’s heating and cooling needs increase.
It is the second-largest physical commodity futures contract in the world by volume after crude oil.
The most popular natural gas futures: NG, HH, and QG
Reformulated Gasoline Blendstock for Oxygen Blending
If you have never heard of RBOB gasoline, you will be surprised to find out that it is the third most widely traded energy futures contract. RBOB is a refined crude oil product that is mainly used for ethanol transportation. Its prices are positively correlated with those of crude oil.
The reason for its popularity is rooted in the link with crude oil. The RBOB product is imported when crude oil producers don’t have the means to refine gasoline and want an alternative. RBOB is considered the most essential refined byproduct of crude oil.
RBOB futures are a useful tool to express views on crude oil, weather, consumer behavior, and regulatory action in terms of current and future energy consumption from the investors’ perspective.
Coal is the primary energy source we have been using for most of our history, including heat generation, transportation, and more. Even today, coal is still the dominant source of energy in many developing countries.
However, as we are approaching the end of the “fossil fuels” era, this is poised to change. And while crude oil will continue to be present in our everyday lives under different forms, coal will make way for alternative energy sources. Considering its limited use for purposes outside energy generation, many analysts predict coal will be phased out in the long-term.
This trend is visible even within the trading volumes of the most popular coal futures. Although still traded today, the commodity is way behind the daily trading volumes of crude oil, natural gas, and RBOB.
Humanity’s march towards renewable energy makes biofuels a prevalent investment opportunity. The most popular futures contracts in the biofuels category are based on ethanol as the underlying commodity.
Ethanol is a renewable fuel that can be made from various plants. The raw material for its production is known as “biomass.” When blended with gasoline, ethanol can increase octane and cut down carbon monoxide. The result is cleaner energy that doesn’t cause smog emissions and isn’t harmful to the environment.
Today, there are disputes about whether biofuels should be referred to as “green” energy sources. Although they are better for the environment than traditional gasoline (produce lower CO2 emissions and the same or lower levels of hydrocarbon and oxides of nitrogen emissions), they aren’t completely harmless.
This means they won’t be at the forefront of the renewable energy revolution going forward, although they would surely benefit from it.
Many beginner traders are lured by the liquidity and profit opportunities of energy futures. However, trading them requires mastery and an in-depth understanding of the underlying commodities and their application.
There are many different types of energy products, and each of them can have several ends uses. Let’s take crude oil, for example. Just for fuel production, it is used for refining a variety of products, including diesel, gasoline, propane, jet fuel, and more. Add to that textiles, sports goods, plastics, electronics, health and beauty products, household inventory, medical supplies – these and much more make a list with the crude oil uses.
So, if you are targeting energy futures as your entry field, you should be aware of the essential factors that drive the commodity’s price to better manage your investments. Let’s go through the most prevalent factors affecting the price of the underlying commodities to help you on your journey within the energy niche:
1. Supply and demand
Like any other asset, commodities’ prices are driven by natural market forces. If there is an equilibrium between the buyers and sellers, the price will be stable. If one of these prevails, the price of the commodity will experience an upward or downward change.
The supply and demand for energy products are dependent on the state of the economy (from both the consumer and industrial sectors) and the population’s needs. For example, if the economy is booming and individuals have more disposable income, they will purchase more goods. Considering that crude oil is crucial to the production of many goods. To address this growing demand for goods, producers will have increased demand for crude oil.
Another example is the world travel and leisure industry. As crude oil is the basis of all fuels (e.g., vehicles or jets), any adverse effects on transportation result in price fluctuations for the commodity. A notable example is when the global air fleet was grounded due to the COVID-19 pandemic. This resulted in very high storage utilization and low demand, creating disparity within most energy commodities. As a result, for the period February 17 – April 20, 2020, when the world first felt the pandemic’s magnitude, the price of crude oil fell by close to 70%.
The fact that all energy products are used for heating and cooling, under one form or another, should be a warning sign that the seasonality effect is detrimental to their price.
During the winter and the summer, the energy demand will be higher than usual. On the other hand, during the autumn and the spring, when temperatures don’t fluctuate, energy consumption is lower.
Besides, there are peaks in traveling during summer, which, combined with the increased energy demand, further affects the commodities’ price.
The good thing is that the seasonality effect is relatively stable, easily predictable, and proven time and time again. This means if you get the basic principles right, there won’t be anything to catch you off-guard.
3. Geopolitical situation
The energy market is an international market, which means that you should keep an eye on the developments and relationships between the most prominent players in the industry on an international scale as a trader.
To do that, you should get familiar with the energy mixes of the major markets globally and find out which countries are net importers and exporters of energy (and what type). Although this might sound a bit complicated at first, the truth is that the global energy world’s major powers aren’t so diversified.
Start by keeping an eye on the OPEC countries, the US, Canada, China, and Russia, for crude oil, natural gas, and coal. You can expand that list if you plan trading biofuels or renewable energy with some of the countries in South-East Asia.
Once you are familiar with each of the leading countries’ energy profiles, make sure to keep an eye on global policies, restrictions, and conflicts on a macro level and local developments within each of these countries. That way, you will better predict the supply and demand dynamics and hedge your energy futures trading portfolio against geopolitical risk.
4. The Build and Drawdown Cycle
The leading energy products, including crude oil and natural gas, go through the so-called “build and drawdown cycle.” The build phase includes the extraction of the raw material from the ground, its transportation and storage into special facilities. The drawdown phase of the cycle is when the product is delivered to the end-user.
The bottom line is that higher demand and lower supply lead to a drawdown in inventories, while a higher supply and lower demand result in an increase in inventories. Naturally, this affects the price of the different energy products. To better forecast the price changes, traders must keep an eye on the build and drawdown data.
The best sources for this are the weekly reports from the EIA and API. These reports feature valuable information, including stock performance, production insights and trends, refinery utilization, imports/exports ratio, demand dynamics, and more.
5. Market dynamics – current state and forecasts
Price fluctuations within energy products are usually driven by a combination of actual data, forecasts, and assumptions regarding the market’s future state. These include projections for the natural gas consumption during the winter months, airlines’ analyzing travel trends and demand for their services, etc. According to these estimates, market participants can then purchase the quantity they believe they’ll need.
Another factor that falls in this category is the weather forecast. The parties with interest in the energy market keep track of the weather forecasts. This helps them find out if they can expect any anomalies during the winter or the summer. That helps quantify their effect on the price of the commodities. With weather forecasts, however, the accuracy tends to get higher the closer you are to the particular season, so energy traders also have to time the market.
The dynamics within the market for the underlying commodities make energy futures trading an exciting field poised to grow even more in the future. Globalization, economic and technological progress, increased population, climate change – these dominant forces will continue to drive the energy demand further, while the supply will seek additional ways to catch up.
With the growing popularity and the increased necessity for a transition to green energy, which will further enhance the spectrum of investable assets within the energy niche, traders have many opportunities to capitalize on.
The price of a commodity will never go to zero. When you invest in commodities futures, you’re not buying a piece of paper that says you own an intangible piece of a company that can go bankrupt.
– Jim Rogers
The key to making the most out of the energy futures trading and capitalizing on its potential is understanding the unique factors that influence the price of the underlying commodities and staying up-to-date with the industry-specific information.