While many people know that contracts for difference can be used on stock indices, not so many traders think of CFDs for profiting from commodities, such as energy products. When commodities are mentioned, the trader may naturally think of futures contracts. However, CFDs are available on most financial instruments and are easier to trade than other contracts. CFDs are always traded speculatively and cash settled, avoiding any confusion about deliveries, and commodities CFDs usually have no commission charged and a low margin requirement of about 3%, depending on the CFD dealer.
While not traded as much as oil CFDs, natural gas CFDs suffer less fluctuations and tend to be easier to predict, which makes them popular with trend followers. Supply-side pressures have been pushing up prices, and traders who have taken advantage of this have profited. Gas CFDs are available on both the US and the UK markets.
Unlike oil CFDs, natural gas CFDs are usually traded on the futures market and not the spot market. Trading CFDs has the advantage that you are not limited to the large lot sizes required on the futures market, and you usually get a better margin with CFDs than futures. This means you have a much reduced entry level, allowing flexible trading and diversification.
Gas Prices in relation to Crude
Natural gas is a relatively ‘clean’ source of energy, much cleaner than coal and oil. Just to get this into perspective modern gas power stations emit up to 70% less carbon dioxide than coal plants. The Fukushima nuclear plan disaster has also made gas look like a more favourable option compared to nuclear power – and nuclear power has in the past been considered another low-emission alternative to gas as far as power generation is concerned.
The increasing use of shale gas has hit the price of USA natural gas hard and unlike crude oil which has recovered from the lows seen in 2008, natural gas prices have remained under pressure. This can partly be attributed due to the fact that the main users of Natural Gas are domestic users (heating and cooking), industrial factories and power stations while about half of global oil production is used in transportation and the excess of supply driven by the rise of shale gas hasn’t helped natural gas prices. Indeed, shale gas extraction has increased rapidly in the last few years in the USD,, with annual shale production having increased more than ten-fold from 11 billion cubic metres (bcm) in 2000 to about 138 bcm in 2010. Having said that, compressed natural gas (CNG) and liquefied natural gas (LNG) are increasingly being used in India and China as fuel to power transportation. The Energy Ministers of the Forum of Gas Exporting Countries (GECF), which unites together eleven of the world’s largest producers of natural gas, recently agreed to act in unison in a bid to increase gas prices and achieve parity in comparison with oil prices. In particular, the Algerian minister Chakib Khelil suggested a ratio of 1 to 6 between the price of Gas and Oil.
In the past two years, there has been a bearish divergence in the price of natural gas in relationship to Crude. With parity from 1 to 6 characterized by the GECF, the input and output signals in natural gas are going to strengthen greatly, creating opportunities for several strategies, including pairs trading or spreads trading between the two assets.
Trading Gas Contracts
Investing in natural gas used to be quite complicated and unusual as trading uranium, but CFD traders can now buy and sell CFDs on Natural Gas futures quoted on NYMEX.
Because the CFDs are linked to futures contracts, there are several contracts available with different expiration dates. Each CFD is derived from a different underlying futures contract. Usually the first month and the following month are quoted by the dealers, and these contracts are cash settled on the expiry date. As an alternative, some brokers offer continuous contracts with automatic rollover.
As an example of how this works, say US natural gas is currently being quoted at 5.384 to 5.404. As this is a US contract, the prices are quoted in dollars, and the unit is mmBtu, a measure of the amount of heat available from the gas. It actually corresponds to about 10 ft.³ of gas, depending on the source of the natural gas. The standard contract size for the CFD is 500, so the nominal value of the contract is $2702 to take a long position. Because of the margin facility, each contract that you buy would require only a couple of hundred dollars, depending on the dealer’s requirements. Say you buy 10 contracts to control a total of $27,020 worth of natural gas.
Assume that the contract price goes up to 5.438 to 5.458, an increase of about 1%. To exit the trade and take your profit, you would sell ten standard contracts, which at 5.438 would amount to $27190. This would give you a profit of $170, a good return on a couple of hundred dollars invested.
It is worth noting that with CFDs it is as easy to go short, if you think the price going down, as it is to take a long position. You still benefit from excellent leverage on your investment, cash settlement, and ease of taking a position, and you also receive a little interest daily into your account.