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Energy prices can be extremely volatile due to the fact that it is probably the most tactical material in the world. The price of energy affects not only industries, but nations as well.

It is important to note that trading in this market involves substantial risks and is not suitable for everyone, and only risk capital should be used. Any investor could potentially lose more than originally invested.

What are energy futures contracts?

An energy futures contract is a legally binding agreement for delivery of crude, unleaded gas, heating oil or natural gas in the future at an agreed upon price. The contracts are standardized by NYMEX as to quantity, quality, time and place of delivery. Only the price is variable.

Advantages of Futures Contracts

Since they trade at a centralized exchange, futures contracts offer more financial leverage, flexibility and financial integrity than trading the commodities themselves.

Futures contracts offer speculators a higher risk/higher return investment vehicle because of the amount of leverage involved with commodities. Energy contracts in particular are highly leveraged products.

For example, one futures contract for crude oil controls 1000 barrels of crude. The dollar value of this contract is 1000 times the market price for one barrel of crude. If the market is trading at $60/bl., the value of the contract is $60,000 ($60.00 x 1000 barrels = $60000). Based on exchange margin rules, the margin required to control one contract is only $4050. So for $4050, one can control $60,000 worth of crude. That gives one the ability to leverage one dollar to control roughly $15.

Contract Specifications

Energies are traded a few different exchanges around the world, in London and now at ICE. In this piece, I am only looking at the contracts traded at NYMEX.

Crude

Crude accounts for 40% of the world's energy supply and is the most actively traded commodity contract worldwide. Crude is the base material that makes gas, diesel, jet fuels and thousands of other petrochemicals.

Crude is traded in dollars and cents per barrel. As in the example above, when crude is trading at $60/bl, the contract has a total value of $60,000. For example, if a trader is long at $60/bl, and the markets move to $55/bl, that is a move of $5000 ($60 - $55 = $5, 5 x 1000 bl. = $5000).

The minimum price movement or tick size is a penny. Although the market frequently will trade in sizes greater than a penny, one-penny smallest amount it can move.
Crude has a daily limit of $10/bl, which is expanded every five minutes as needed. This means crude will never be lock limit up or down. Remember, $10barrel is a move of o$10,000 per contract.

The requirements of the exchange specify delivery to many numerous areas on the coast and inland. These areas are subject to change by the exchange.

Since energy is in such demand, is it deliverable all 12 months of the year.

To maintain an orderly market, the exchanges will set position limits. A position limit is the maximum number of contracts a single participant can hold. There are different position limits for hedgers and speculators.

Heating Oil

Heating oil accounts for 25% of the yield of a barrel of crude, second only after gas. Heating oil is used by a wide variety of businesses to hedge their exposure to energy cost.

Heating oil is traded in dollars and cents per gallon. One contract of heating oil controls 42000 gallons or one rail car. When the price of heating oil is trading at $1.5000/gl, the cash value of that contract will be $63000 ($1.5000 x 42,0000 = $63,000).

The tick size is $0.0001 per gallon, which equates to $4.20 for each contract. For example, if one was to go long at $1.5500 and the markets moved to $1.5535, one would have a profit of $147 ($1.5535 - $1.5500 = $0.0035, $0.0035 x 42,0000 = $147). Conversely, a move to $1.5465 would equal a loss of $147. Heating oil daily limit is $0.25, which is $10,500 per contract.

Heating oil is deliverable for 18 consecutive months.

Heating oil, like crude also has position limits set by the exchanges.

Unleaded Gas (RBOB)

Gasoline is the single largest refined product in the US and accounts for half of the national consumption of oil. Besides the large demand for gas, there are numerous of other factors, like government laws, which can affect the price.

RBOB (reformulated gasoline blendstock for oxygen blending) is a newer blend of gas which allows for 10% fuel ethanol.

Gas is traded in the same 42,000-gallon (1000 barrels) contract size as heating oil. It is also traded in dollar and cents, so if the market is trading at $2.00/gl, the contract will have a value of $84,000 ($2.00 x 42,000 gal = $84,000). Like the rest of the energies, this is a high dollar value contract and is quite leveraged. The daily limits here equate to a move of $10,500 per contract or $0.25/gl.

The minimum tick size is $0.0001 or a total of $4.20 for each contract. So any 10-cent move in unleaded gas will equate to either a gain or a loss of $4200.

Gas is also deliverable all year round and has position limits.

Natural Gas

25% of the total energy consumption in the United States is natural gas. Within the 25%, half is used by industry, the other half by commercial and residential users.

Natural gas is one of the bigger futures contracts that is traded worldwide. One contract equals 10,000 MM Btus (million British thermal units). If the current market price is $6 per MM Btus, the contract has a value of $60000 ($6 x 10,000 MM Btus = $60,0000).

The minimum tick is $0.001, or $10 per tick per contract. For example, let's say you buy a contract of natural gas when the market is at $6, and then sells it $7. In this transaction, you would have made $10,000 on the $1 move in natural gas.

Like the rest of energies, natural gas is deliverable all year round and has position limits.

Hedgers and Speculators

The primary function of any futures market is to provide a centralized marketplace for those who have an interest in buying/selling physical commodities at some time in the future. The energy futures market helps hedgers reduce risk associated with adverse price movements in the cash market. There are numerous hedgers in the energy markets since almost every industrial sector uses energy in some form.

The energy complex is quite volatile and takes quite a bit of capital to get involved. There are new eMiny contracts available which are growing in volume month by month.

Hank King is one of the principals and co-founders of Trendphonic Futures Trading, LLC. Hank started his career in 1998 with Morgan Stanley as an Account Executive in Atlanta, GA. In 2000, he moved to Chicago to work with Fimat as a clerk in the grain room at the Chicago Board of Trade. While working with Fimat, Hank worked as a phone clerk and as an arbitrage clerk. From there he has worked in the futures industry with Lind-Waldock and LaSalle Futures Group before deciding to open Trendphonic Futures. Hank has been quoted in Bloomberg, Investopedia.com, Inside Futures and regularly contributes to Farm Talk on KQLX. Hank graduated from the University of Arizona with a major in Art History.

Trendphonic Presents the... T4 Trading Platform

T4 is a lightweight, high performance futures trading system used by CBOT professionals and retail traders alike. This fully hosted internet based system provides global access to multiple futures exchanges. Sign up for a Demo Account today and receive a COMPLIMENTARY Managed Futures booklet!