Natural Gas Options Explained

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Natural Gas Options

Natural Gas Options are commodity based options with the underlying asset being a natural gas futures contract. These futures contracts are agreements between buyers and sellers, to take delivery of an agreed quantity of natural gas on an agreed delivery date. The options contracts are affected by price movements in the futures contract, which in turn, is affected by the market price of natural gas itself.

If you own a natural gas call option, you will profit if the price of natural gas futures rises. This is because a call option gives you the right but not the obligation, to take a long position in the underlying futures. If you have purchased a natural gas put option, you’re hoping for a fall in natural gas futures because put options give you the right but not the obligation to take a short position in the futures. Once the options expiration date has passed, your rights to profit from either of these price movements will cease.

Where Natural Gas Options are Traded

The place to go for these options prices is the New York Mercantile Exchange (NYMEX). The NYMEX Natural Gas Options are “American style options” which are priced in US dollars and quoted against an underlying futures contract covering 10,000 btu’s of natural gas. Natural gas futures are the second most popular energy product traded on the Chicago Mercantile Exchange (CME) so options for them are quite liquid.

If you’re bullish on the price of natural gas, you could either buy call options, a bull call debit spread, or sell a bear call credit spread. If you’re bearish on natural gas prices, you could buy put options, or a bear put debit spread, or sell bull call credit spreads. If you don’t know which way the price of natural gas will go but believe that its price action will soon become volatile (natural gas is a notoriously volatile commodity), you could use straddle or strangle option strategies.

Why Options and Not Futures?

The advantage of trading natural gas options instead of their underlying futures, is that you have more opportunities for a variety of trade setups using any number of option trading strategies, some of which are mentioned above. Futures contracts don’t provide this flexibility. Not only that, but with options, your potential losses are always limited to either the amount invested, or the margin required for the positions, depending on the type of strategy you’re employing. Losses on adverse movements in futures contracts are potentially unlimited.

Moreover, since your options positions are based on the underlying futures contract, you gain additional leverage on price movements. Options on futures are much cheaper than the futures contracts themselves. However, you could also combine options with natural gas futures contracts. For example, you could hedge long futures positions with put options, or short futures positions with call options. Because the pricing models of these derivatives work differently, you can often use this to realize an overall profit. You could also construct a covered call type setup using both long futures and call options.

There are many interesting alternatives.

With natural gas options you should always be aware of option time decay (sometimes called theta decay). If you’re an option seller, this works to your advantage, but if a buyer, your out of the money positions will erode rapidly as expiration date approaches.

To start trading natural gas options, simply open an account with any reputable broker such as ThinkorSwim by TD Ameritrade and you’ll have the choice of trading futures, options, or both.

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Your Natural Gas Pricing Options

Many customers are eager to find ways to reduce their natural gas bills, and one of the most effective ways to save up to 30% on your natural gas costs is to buy your gas from a different supplier.

Unfortunately, it can be quite difficult to understand what alternative option is best for your home or business. This is largely because the best alternative depends on how you are currently paying for your natural gas and what market you are in.

When EnPowered enters a market, it looks at all the options available in the market and finds the best available option for homeowners and small businesses. It then creates a group-buying model to help its customers get the lowest rates for that type of plan. In other words, we will do the work of making sure that you are getting the best rate for your specific needs.

EnPowered is working hard to enter new markets, and as we do so we will create targeted guides to help you understand exactly how to save money in each market. This article serves as a general guideline on the options available across all deregulated energy markets, and can be used to help you understand your options, as well as which alternative natural gas option is best for you.

In nearly every market, regardless of where you are, you will generally have a default supply rate provided by your local utility. If you are not sure what you are paying right now, chances are you are with your local utility paying your default rate. If you are in a deregulated energy market, you can choose a different rate for your natural gas from independent energy retailers. To see which markets are deregulated, see our earlier post on Energy Deregulation

These retailers are only responsible for changing the price that you pay for the natural gas supply itself; you will keep receiving the same emergency services and support from your utility. As a result, many customers are paying more for their energy than they could be paying if they were to switch.

Understanding Your Bill

To understand exactly what portion of your bill you are able to control, it is helpful to first explain how your bill is broken down. Although pricing is different in every market, most bills can be broken down into four main parts.

Natural Gas Supply Charge: This is the cost for the natural gas itself. This charge usually makes up about 80% of the bill for most of us, and this is usually the most volatile part of your bill. If your bill goes up and down a lot over time, this is probably what is causing that to happen.

Delivery Charge: This is the cost of getting the gas to your doorstep. This will include the Transmission costs to get your gas from where it is produced to your region, as well as the Distribution costs to get your gas through all the local pipes directly to your doorstep.

Regulatory Charges: These can vary a lot from region to region, but this is usually a relatively small cost attached to your bill to cover the costs of managing the market. These fees will usually go to your local energy board, or the system operator in your area.

Taxes: These will also vary from region to region, but are generally the sales taxes charged in your area.

Regulatory charges and Taxes are pretty stable but the Supply and the Delivery costs are far more volatile. You are usually only able to control the Supply cost portion of your gas bill.

When looking at how to control your energy Supply cost, the many options in the market can seem confusing. Every retailer in the market will charge a different rate, and will often even have a unique plan for their customers. In general, though, the alternative pricing options available in the market fall into one of three pricing types: flat payments, fixed rates, and variable rates.

Standard Retailer Options

Flat payments: This is the simplest option, but it is only available in certain regions and usually only for residential customers. With this plan, you pay a certain price every month (i.e., $50) regardless of how much natural gas you use. This option is ideal if you are a homeowner that is looking for stability to be able to budget your expenses, but it can lead to you over-paying over the course of a year.

Fixed rate plans: With a fixed rate plan, you are able to lock in your energy rates at a set price. In this way, you are able to predict your energy costs in advance and are no longer at the whim of the markets. These plans can vary in length from only a few months to up to five years in length. Similar to locking in low interest rates, fixed rate plans allow you to lock in low gas prices for years to come, allowing you to gain control of your costs.

Variable rate plans: With a variable rate plan, you will pay a different rate each month based on what the market rate for gas was that month. Variable rate plans are usually calculated as the market rate plus a small admin fee that is paid to the retailer. For example, a plan may offer the average market price plus one cent per unit of gas. Similar to variable interest rates, these plans can become quite cheap if prices drop, but also leave you open to the risk that prices could rise in the future.

So What Does this mean to you

Understanding which of the three types of alternative pricing plans makes sense in your market depends on how you are currently paying for your gas. Every country, every state, and sometimes even every utility has a different way of charging for their gas.

We have listed the five most common ways that your utility is likely charging you for your default supply, and for each one we have listed which alternative is generally best for you.

Flat rates

What is it: This is the simplest and also the most common type of rate. Every few months, or sometimes only once per year, the utility sets a new price for natural gas. This price will be stated as a certain number of cents per kWh that you use.

The problem: This price is very simple to understand but will not reflect the market costs for natural gas and can lead to consumers overpaying for their gas.

Recommendation: A variable plan will often allow you to more closely match the true cost of the gas market and pay less over the long-term.

Seasonal rates

What is it: These rates are very similar to flat rates, only the rates change between the seasons as demand fluctuates, usually between winter and summer.

The problem: The utility will often charge much more for the natural gas during the summer to try to incentivize users away from using gas, often charging much more than market rates.

Recommendation: In these markets it can make sense to get a fixed rate plan to lock-in low rates during the winter before rates rise in the summer months

Variable rates

What is it: In certain markets, the utility will simply pass on the cost of natural gas to their customers. This is usually only done for larger businesses and is rarely done for residential or small business customers.

The problem: In some markets prices are on the rise, and staying on a variable rate will lead to you paying more in the long-term.

Recommendation: In these markets it can make sense to get a fixed rate plan to lock-in low rates before prices rise

Things to look out for

Unfortunately, as in any industry, not every company in the energy retail space operates fairly. EnPowered works hard to ensure that its contracts are fair to its customers, but if you are looking to sign with a different retailer plan there are a few things that you should look out for.

Hidden fees: Sometimes companies will try to sneak hidden fees into your contracts, such as adding an additional delivery charge or membership fee to your contract.

High cancellation fees: Some companies will charge extremely high cancellation fees to keep you locked-in to a contract. Some fees are to be expected, but they should be reasonable. This cancellation fee will usually be worded as a few cents/m3 remaining in your contract. The industry average fee is already quite high at around 5.0 cents/m3, so be wary of any contract charging a higher fee than that.

Really long terms: You should always understand how long your contract will be for. Many companies will sign you up for long-term contracts, such as five year terms, at higher rates. Unless you are looking for a long-term contract, EnPowered would normally recommend no more than three year terms.

Auto-renewal clauses: A lot of companies will try to automatically renew your contract at the end of your term, make sure that you have the ability to cancel your contract in such situations.

This article is meant to be a general guideline of the options available in the market, and what options you should take advantage of to reduce your energy bill. If you are wondering whether or not you are able to choose one of these alternative options in your market, or if you are curious about how the market works, we have written a post about Energy Deregulation. We have also written a post about your Electricity options for those who are looking to control their electricity costs.

Exploring your options in the energy retail market is a great way to take charge of your energy usage and to reduce your natural gas bill. If you want to know more about exactly what options are available in your market, we will be working hard to create targeted articles for each market on our blog.

Natural gas and the transition to net zero

Today, natural gas allows billions of people to enjoy access to lower carbon heat and power. And, as the world works towards net zero emissions, we think natural gas will play an important role in getting us all there

How can gas be part of a low carbon world?

  • Natural gas has far lower emissions than coal when burnt for power and is a much cleaner way of generating electricity. Switching from coal to gas has cut more than 500 million tonnes* of CO2 from the power sector this decade alone.

And, as electricity production increasingly switches to renewable sources, gas is a flexible partner to wind and solar, providing quick and reliable back-up power whatever the weather. This gas + renewables partnership has helped the UK to lower emissions to levels last seen in the 19th century.

BP is leading on tackling methane emissionsto help maximise the climate benefits of gas. That means reducing flaring and minimizing methane leaks. BP was among the first of the energy companies to set a stringent target of 0.2% for methane emissions. BP was the first to commit to continuous methane measurement for all our new oil and gas projects. To achieve this, BP adapted technology from NASA’s mission to Mars, the medical sector and the defence industry to deploy drones, lasers and cameras across its operations. BP is a signatory of the Methane Guiding Principles, an initiative to help lower methane emissions across the industry.

Looking ahead, natural gas can be decarbonized. When it’s burned to generate power or heat for industry the carbon dioxide generated can be captured so that it doesn’t reach the air through using carbon capture, use and storage (CCUS) technologies. And, it can also be used to produce hydrogen, which produces water-vapour when burned. Through the Oil and Gas Climate Initiative and the Net Zero Teesside project, BP is working to accelerate the potential of CCUS to take the carbon out of hydrocarbons. And, as a member of the Hydrogen Council, BP is supporting hydrogen as a key element of the energy transition.

Energy illustrated – episode 4: natural gas

In the fourth instalment of Energy illustrated, Spencer Dale looks at the role natural gas plays in the provision of the world’s energy. With renewables becoming the world’s fastest growing source of energy, natural gas provides the ideal compliment in making up the remaining requirement.

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