Published on EBF 301: Global Finance for the Earth, Energy, and Materials Industries (https://www.e-education.psu.edu/ebf301)

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Lesson 3 - The New York Mercantile Exchange (NYMEX) & Energy Contracts

Lesson 3 Introduction

Overview

In 2008, the price of crude oil on the New York Mercantile Exchange (NYMEX) hit an all-time high of $147 per barrel. And, within (6) months, the price had fallen to about $35. Again, in 2014, oil was over $100/Bbl in June only to fall to below $50/Bbl by December. While many factors led to these "peaks and troughs, the nature of futures trading and the exchange itself made this possible. The New York Mercantile Exchange has been around since the late 1800s. Financial energy commodity contracts, such as futures contracts, are traded on the New York Mercantile Exchange, and it is still the most influential financial energy commodities exchange in the world. Futures contracts are financial tools to hedge against the price fluctuations. In this lesson, we will explore the history of the exchange, how it functions, who participates, what commodities are traded and futures contracts. In this lesson, we will also learn about the NYMEX order flow. Standardized Order Forms are used on the floor of the NYMEX during order execution. All orders placed on the NYMEX to buy or sell contracts are done in a very precise manner where each party involved is fully aware of the details of the transaction.

Learning Outcomes

At the successful completion of this lesson, students should be able to:

  • explain the history and development of the exchange;
  • identify the components of a standard NYMEX contract and which commodities are traded;
  • list the specific contract specifications for:
    • natural gas,
    • crude oil,
    • heating oil,
    • unleaded gasoline;
  • describe the importance of the “price discovery” function provided by the exchange for energy commodities;
  • know the difference between “pit” and electronic trading;
  • recognize various exchange “floor” personnel and players;
  • explain NYMEX - order execution & electronic trading:
    • list the order flow from the physical customer through the exchange,
    • recognize that very few contracts ever actually get delivered physically,
    • explain the electronic trading and "high-frequency trading" for futures contracts;
  • identify information about the futures market including risks, functions, regulators, margins, motions, price, short and long positions;
  • explain the concept of the “zero-sum” game in financial contracts;
  • recognize and research the various factors impacting supply and demand for natural gas and crude oil for this week and assess their potential impact on market pricing for each factor.

What is due for Lesson 3?

This lesson will take us one week to complete. The following items will be due Sunday at 11:59 p.m. Eastern Time.

  • Quiz
  • Fundamental Factors
  • Nymex Prices Activity

Questions?

If you have any questions, please post them to our General Course Questions discussion forum (not email), located under Modules in Canvas. The TA and I will check that discussion forum daily to respond. While you are there, feel free to post your own responses if you, too, are able to help out a classmate.

Reading & Viewing Assignments: Lesson 3

Reading Assignment:

  • Seng - Chapters 3, 4, 5
  • Errera & Brown - Chapter 2, "Market Mechanics" in preparation for this week's quizzes.
  • "A Brief Review of the History of Futures [1]”. You can find this article in Canvas Module Lesson 3.

Optional Materials

Please take some time to review the optional materials. They will give you context for the rest of the lesson.

Optional Readings

Bloomberg article "The Impact of Physical Commodity Supply Trends on Financial Market Behavior". You can find this article in Canvas Module Lesson 3.

Investopedia Article and Video

Futures Contract [2]: read the article about futures contracts and watch the 1:37 minute video

What are Futures Video (20:30 minutes)

Printable Transcript: What are Futures? (Word document) [3]

The New York Mercantile Exchange

Financial energy commodity contracts are traded on the New York Mercantile Exchange (NYMEX). The New York Mercantile Exchange building is located on the Hudson River in New York City and owned and operated by CME Group of Chicago (Chicago Mercantile Exchange & Chicago Board of Trade). NYMEX has offices in other cities as well (Boston, Washington, Atlanta, San Francisco, Dubai, London, and Tokyo.) The New York Mercantile Exchange [4] started in the 1800s. There were scattered markets for the goods in large cities. You can picture a city like New York City and agricultural products being brought in and sold in various parts of it. So, some entrepreneurial businessmen decided that they needed a central exchange. So, in 1872, it was founded as the Butter and Cheese Exchange. In 1880, it was changed to the Butter, Cheese, and Egg Exchange. And then, finally, in 1882, it was changed to its present name, the New York Mercantile Exchange.

Later products would include yellow globe onions, apples, potatoes, plywood, and platinum. Platinum is the only one of these products which is still traded today on the New York Mercantile Exchange. Today, it trades crude oil, heating oil, gasoline, propane, natural gas, platinum, and palladium.

For a quick overview of the Exchange, view this "This is NYMEX" video (2:20 minutes).

This is NYMEX
Click for the transcript.

[MUSIC PLAYING]

PRESENTER: New York City, financial capital of the world. Home to global giants in banking, investing, and finance.

AUDIENCE: We only have four and 1/2.

AUDIENCE: Sell 20 and 1/2.

PRESENTER: Where there is always a transaction on the table, money on the line, and business never sleeps. It's also home to the New York Mercantile Exchange where billions of dollars in commodities are traded every day, but one way or another, impact business and consumer alike.

[MUSIC PLAYING]

[CALLS AT MERCANTILE EXCHANGE]

PRESENTER: What appears, at first glance, to be pure pandemonium, is in reality, a very structured business, as highly choreographed and orchestrated as any Broadway show. The New York Mercantile Exchange is a marketplace for buying and selling futures and options contracts in commodities. For instance, energy products such as crude oil, natural gas, gasoline, home heating oil, propane, and electricity, as well as metals like gold, silver, copper, aluminum, and platinum.

But what does that matter to me, you might ask. Here's an example. Oil refiners sell fuel-- mainly gasoline, heating oil, diesel, and jet fuel. Airlines buy large quantities of jet fuel. It's similar to heating oil, and the two products are often priced within a few cents of each other. As price protection against unexpected increases in the cost of jet fuel, an airline can buy a heating oil futures contract at today's known price for use in the future.

If prices rise tomorrow, the airline saves money by having locked in a lower fuel cost. That's called hedging. The fuel savings could mean lower airfares for you and me. The same principle applies to heating oil we use to keep our homes warm in winter, and the gasoline we buy for our cars. When companies protect themselves from volatile prices, they can help pass along those savings to their customers.

Price transparency is a key advantage to doing business on the Exchange. Everyone knows the price of all contracts being bought or sold. This benefits the entire marketplace and builds confidence and credibility for business and consumer alike.

90 bid!

Source: Morris Product Group

Futures Contracts and NYMEX

Futures contract

Forward and Futures Contracts Crude Oil (11:02)

Click for a transcript

okay let's start reviewing what are the futures and before that I will need to explain forward what contracts first. So, forward contracts, let's say on the left-hand side we have an oil producing company on the left on the right hand side we have a refinery which consumes oil and produces some refined products. So, on the left hand side we have producer that sells the oil on the right hand side we have consumers that buys the oil. So, let's say right now the refinery needs some crude oil the producer has some oil. They just sell and buy and that's it. Okay, but this is an ongoing business activity, right? The producer knows that for anytime future they know the production rate and they know how much crude oil they will have in the future. Also refinery this is a continuous production process, they know they're going to need a crude oil for almost any time in the future, right? Both of these are concerned about market fluctuations and also they want to make sure they market for crude for the produced crude oil or they can have the crude oil that they need. And also they're concerned about the price. The producer is concerned that, okay what if price drops, we're going to lose money. On the other side the refinery is concerned that if price goes up we're going to lose money and they want to hedge their risk against price fluctuations. So what we can what they can do is, they can negotiate a contract which is called forward and they can discuss three things: time, price and quantity. And let's say we are going to sign a contract that sometime in the future, let's say in November, at the locked price of 50 dollars the producer is going to deliver some specific quantity of crude oil let's say 5000 barrels to the refinery. So, they have a contract that locks the price for delivery in some time in the future and they can have many of these. So, this is called forward contract. And by doing that they first make sure the producer has a market for crude oil, the consumer they know for sure they will have crude oil in November. Also, they know the price is locked. The price is locked. They lock the price 50 dollars. The price doesn't change. Okay what are the kind of them restriction, limitations, of these forward contracts?

Okay first let's say these two entities, the producers and consumers, they're not exactly the same size. Let's say the refinery is a very large, or the producer is very large producer, one of them is a lot smaller or larger than the other one. So, then, they have to go and probably find 10 other counterparties to find, negotiate, and sign the contract for each of them and they have to do it for almost every month, soon and so forth. It's doable, it is still uh an ongoing activity in the financial market, but it's not the most efficient way of doing it.

The other problem with this is, let's say this contract is signed to deliver the crude oil in November and the price is locked at 50 dollars. Let's say, a couple of months to the November, let's say price of crude oil goes up. Let's say it goes to sixty dollars. So, if it goes in the market it's sixty dollars, but under this contract it is locked at fifty dollars. So, because it is locked, then, the producer loses money. Because, if there was no contract producer could have sold it in the market at sixty dollars. So, the producer will get more and more upset that, okay, I am losing money under this contract, but there is no way that they can cancel the contract. On the other side, if price of crude oil starts going down, the producer is happy but the consumer cannot uh cancel the contract and go and buy the cheaper oil in the market. They have to pay the 50 dollars for locked price. So the problem is they cannot cancel the contract at all.

So, this is the kind of the introduction how there is a better more efficient type of contract needed based on the forward and that's going to be called futures, which I’m going to explain in in a bit.

Okay, now let's make some changes and move toward that more efficient contract which we'll call it later on futures. Okay, the first thing that we want to do is, we want to introduce the third party here. And let's say, we call this third party, and say instead of producer going and trying to find consumers, these producers will just go and sign a contract with this third party, call it exchange or call it a businessman, businesswoman, a company. And the consumer, the refinery, will also go and signs the contract with this third party. So, it solves the problem that they don't need to go and find, let's say 10 more, consumers and sign individual contracts for them.

Let's make some little more adjustments. Let's say we make these contracts standard. You remember in the previous slide I said look at these contracts, these forward contracts are case based? they are signed for the specific case and between these companies and their contract terms are negotiated between these two entities?

Now let's introduce a type of contract that is, all the terms are standard, there's nothing negotiable. These are all fixed in place and nobody can change them. The quantity is fixed, the delivery point is fixed, the price is fixed, which I’m going to talk about the price in a bit. And everything is fixed under these contracts, except the delivery date. And delivery date goes by the incremental month. It's either January or February or March, so on. The only difference between these contracts is the delivery date or expiration date. So, when we make these contracts exactly similar, there's no need for any negotiation back and forth. So, we will have these standard contracts and what we can do is we can have all the other entities to join this market and trade these contracts.

So, what will end up with an exchange in the middle, which will have these contracts, they are all standard, exactly the same. And we have these players that the actual producer the refinery and the oil producing can also join as one of these players in the market. So, they can either buy these contracts or they can sell them. If they buy this contract, we call them their position is long. If they sell this contract their position is short.

If they buy the contract, long position, they have to take the delivered crude oil, they will receive the crude oil when contract expires. On the other side, those players, those entities who sold the contract, their position is short. They have to deliver the crude oil, the amount of crude oil at the expiration date.

Because, these all these contracts are exactly the same, these are called futures. They have the fixed quantity, one thousand barrels of crude oil, the delivery point is fixed, Cushing Oklahoma and the spec is WTI, West Texas Intermediate and that's low sulfur, sweet, crude oil and the expiration day goes by the month, January, February, March and so on. The price is set by these trades by these market movements, sell and buy, supply and demand. If somebody does not like the loss that they are making, based on the price movement, they can get out of the contract anytime they want. They don't have to wait until the expiration date. If the prices are going up and the position is short, they can just immediately close the position by buying back, buy closing the position with the exchange.

The entities who are long these contracts, the entities who bought the contracts, will make money, will profit, when price goes up. On the other side, if an entity has a short position, will lose money. If price starts to go down, long position will lose money and short position will make money.

Okay, an important point here, these contracts are binding. The entity, the party that is short, the part that sold this contract, has to deliver crude oil at the expiration date. If that party is not an oil producing company, or if that party is not interested in delivering or cannot deliver the crude oil, they have to close their position, they have to cancel the contract. How? if they are short, they have to buy back; if they are long, they have to sell.

Credit: Farid Tayari
Futures contracts are financial tools to hedge against the price fluctuations. Producers and consumers can use futures contracts to lock the price of a commodity in the future and let the speculators and traders trade the contracts (we will learn this in lesson 7). Consequently, producers and consumers are hedged against the price change and the risk is transferred to the traders and speculators. Traders and speculators bet on the price movements and gain or lose regarding the price behavior. Note that a contact has two sides, and when a trader wants to sell the contract, there has to be a buyer and vice versa. Trading futures contracts is a zero-sum game. If a trader gains profit, the other trader has to lose.

The definition given by the New York Mercantile Exchange is “...a legally binding obligation for the holder of the contract to buy or sell a particular commodity at a specific price and location at a specific date in the future.” The key word here is future. These are known as futures. We are buying and selling energy commodities at a future date and time. And again, this is a legally binding obligation. This is what makes exchanges a sound place to conduct business. If you fail to perform under a contractual obligation with the New York Mercantile Exchange, there are both financial and legal ramifications.

The components of a standard NYMEX energy contract are as follows.

  1. the name of the commodity and exact specifications of the commodity (for example WTI crude oil, natural gas, heating oil, unleaded gasoline;
  2. the quantity and volume of the commodity (for example 1,000 barrels for the crude oil futures contract);
  3. the price, is determined by the market and is normally what we are most interested in;
  4. the location that the commodity has to be delivered;
  5. and then the date, the date that the commodity has to be delivered. At what future point in time do we wish to buy or sell the energy commodity?

Here are the links to the crude oil [5]and natural gas [6] features in NYMEX. These links take you to the crude oil futures quotes [7] and natural gas futures quotes [8]in NYMEX. You can click on the “About This Report” at the bottom right of the table to find the column head explanations. Reported information in the table will be explained later in this lesson.

The trades on the New York Mercantile Exchange between the counterparties are conducted under the International Swaps and Derivatives Association, or ISDA, 2002 Master Agreement. This is a standardized contract under which all financial energy commodity contracts are traded.

Functions of Energy Contracts

Price Discovery

One of the primary functions of energy contracts on the New York Mercantile Exchange is that they provide us price discovery. We can establish a price for crude oil, natural gas, heating oil, and unleaded gasoline at any future point in time. Years back, prior to the advent of the New York Mercantile Exchange, no one could really tell what the price was at any point in time. Most trades were conducted over the telephone. But now, with the New York Mercantile Exchange, at any point in time, you can look up the live trading.

The New York Mercantile Exchange is owned by the Chicago Mercantile Exchange, or the CME Group. If you go to cmegroup.com [9], you can find the commodity prices. Under the "Trading" tab, you can find the commodity and then the commodity futures contract.

Hedging

In addition, this allows us to perform what we call hedging. Hedging is to reduce risk in a transaction. In the case of the futures contracts, it helps us to reduce our price and/or physical risk. We may be concerned about high prices if we're a consumer of energy commodities. We may be concerned about low prices if we are a producer of energy commodities. We may also be concerned about receiving physical supply or having to guarantee physical market. The New York Mercantile Exchange contracts guarantee that.

Futures Market Characteristics

Remember from microeconomics [10]that a perfectly competitive market has the following characteristics: 1) Nobody has market power 2) Product is homogeneous 3) Information is perfect and 4) There is no barrier to enter and exit. Indeed, such a hypothetical market with all these characteristics doesn’t exist in the real world. However, the futures market is one of the closest markets to the perfect competition. There are many buyers and sellers. There is no or very limited government intervention in this market. There is no significant barrier to enter and exit the market, except the legal and financial responsibility of market participants. Traded products are futures contracts that are standard and homogenous for each commodity. In addition to these, cost of information is relatively low. All these features make the futures market an efficient market. And from microeconomics, we know that in an efficient market 1) price is determined by the market dynamics, 2) price represents the true value of the good, and 3) price fluctuates around the true value of the good. These happen because the futures market is highly related to the cash market. A portion (even though it’s a very small portion) of the futures contracts ends in actual delivery.

Note that an important feature of the futures contracts is, gains and losses to each party is settled every day. This is called marking to market or daily settlement. It’s equivalent to closing the contract each day and opening another one for the next day. When opening the position, either long or short, each party only pays a small amount of money, which called margin requirement. The margin is used for daily gain or loss (daily settlements) due to the price changes. And if the loss is more than amount in the margin account, the party has to immediately deposit more money into the account.

The following lecture will take you through the history of the NYMEX, the type of trading that occurs ("pit" vs. electronic), the major players, the commodities traded, and futures contract specifications.

NYMEX Contract Lecture

Figure 1 displays the NYMEX building located on the Hudson River in New York City and the NYMEX trading floor, where all the trades occur. Watch the video lecture at the bottom of this page to learn more about the NYMEX futures contracts.

Left: NYMEX building in NYC. right: NYMEX trading floor with many people/
Figure 1: NYMEX building located on the Hudson River in New York City (left) and NYMEX trading floor (right).
Source: Futures101.ru [11] and Energymaxout.com [12]

Key Learning Points for the Mini-Lecture: NYMEX Contracts

While watching the Mini-Lecture, keep in mind the following key points and questions:

  • NYMEX contracts are legally binding obligations to buy or sell commodities.
  • Contracts are standardized.
  • Each commodity contract has volume, price, location, and date.
  • The NYMEX trades 5 energy commodities along with 2 precious metals.
  • Trading occurs both in the “pits” of the Exchange, as well as electronically.
  • Margin requirements discourage many from "speculative" trading.
  • The Exchange has a unique set of symbols to identify the commodity/month/year.
  • All prices are quoted in US dollars and cents.
  • Each commodity has a specific delivery point.
  • West Texas Intermediate Crude (WTI) is the standard traded on the NYMEX.
  • Futures contracts provide “price discovery.”
  • Market participants include “commercial” or those interested in the physical commodity, and “non-commercial,” or “speculators.”

The following video lecture is 20:30 minutes long.

EBF-301 NYMEX Contracts
Click for a transcript.

Some of the common terms used by NYMEX. An ask-- an ask is a motion to sell at a specific price. It's the same as an offer. So ask and offer are interchangeable. It's your asking price. What do you wish to get in the marketplace for your commodity? And notice this is a motion because they're addressing the idea of the physical trading that takes place in the pits, the movement of hand gestures back and forth as traders buy and sell. A bid, then, is the opposite. It's a motion to buy at a specific price. What is your bid for the energy commodity?

A bull-- in this case, we're talking about a person. It's one who anticipates prices will increase or volatility in the market will increase. They're the opposite of a bear. A bear is one who anticipates a decline in price or the volatility in the marketplace. Obviously, the opposite of a bull.

This is a picture of the New York Mercantile Exchange trading floor. It just so happens in the foreground is the natural gas trading pit. Off to the left, barely seen, is the crude oil trading pit. Notice the various colors of jackets around the floor. I will identify who some of those are in a minute. But the yellow jackets, for the most part, those are NYMEX compliance personnel. The multi-colored jackets, the blues, the burgundies, some of the other colors, represent brokers, what are known as clearing brokers on the floor of the New York Mercantile Exchange. They have posted credit, and they have licenses to trade on behalf of their clients.

So we have the floor brokers, which I mentioned. We have locals. These are the individuals and firms and in some cases funds that have a large amount of money and wish to trade. They are speculators. They're not interested in the physical commodities whatsoever. They're interested in price movement, and wherever the price is moving, that's where they want to be.

Ring reporters and ring chairmen-- we'll drop back here a second, and I will show you. The ring reporters are in the yellow jackets near the trading rings themselves. There is a podium, if you can tell, situated above the natural gas pit with some personnel in yellow jackets. Those are the ring chairmen. Their primary responsibility is to oversee the activity of the pits and to resolve any disputes. Since we have people who are yelling orders back and forth to one another and using paper slips, sometimes mistakes can be made, and if there's a disagreement over the actual details of a trade, the ring chairman is supposed to step down and resolve that trade between the two counterparties.

We have floor committee members. Those are basically NYMEX committee members. The New York Mercantile Exchange also has compliance people. And the Commodity Futures Trading Commission is the regulatory body for energy financial derivative trading. They have their own personnel on the floor as well. And then there are hundreds of line staff from the New York Mercantile Exchange.

We'll now talk about each one of the specific contracts for energy commodities. The first is crude oil. The symbol is CL. We refer to this as West Texas Intermediate, or WTI crude. It is low sulfur, and so, therefore, is given the nickname sweet crude. The NYMEX contract for crude oil was initiated in 1983. Every contract represents 1,000 barrels, which is the equivalent of 42,000 gallons of oil. Price quotes on the New York Mercantile Exchange are all US dollars and cents, in this case per barrel. A minimum price fluctuation-- that is, the amount that the price has to move for a trade to take place-- is a penny, or $10 a barrel.

The delivery point for crude oil under this contract is what's known as FOB, or free on board, or delivered to the seller's facilities at Cushing, Oklahoma and to any pipeline or storage facility with access to Cushing Storage, TEPPCO, or Equilon pipelines. So if you buy or sell crude oil contracts on NYMEX for a particular month, you are obligated to either receive the crude oil or deliver the crude oil at Cushing, Oklahoma.

Deliveries are to be made uniformly across the month. This is the contractual obligation. The idea here is to make all parties deliver as equally as possible. The actual obligation-- for instance, if I sold 30 contracts for the month of September, that means 30,000 barrels of crude oil-- the Exchange would like me to deliver that at 1,000 barrels a day. However, if I cannot, my real legal obligation is 30,000 barrels for the month.

The trading hours on NYMEX for what we consider to be the open outcry or pit trading, the general session where the traders are in the pits yelling orders back to one another, run from 9:00 AM to 2:30 PM Eastern Standard Time. The Chicago Mercantile Exchange also has an electronic trading platform known as Globex, and this is virtually 24 hours a day, seven days a week. It starts at 6:00 PM on Sunday evenings and ends at 5:45 PM on Friday, Eastern Time.

Crude oil can be traded for up to nine years. And then we also have products that are known as strips. These are available for terms of 2 to 30 consecutive months. In essence, strips amount to an average price. If I wanted to buy six months' worth of crude, rather than go out and have my broker quote me one month's price at a time, they'll just give me an average price across the six months. Therefore, I am purchasing a six-month strip of crude oil.

The last trading day, every contract expires. Again, we are talking about future contracts. So currently, the closest future contract is September. The crude oil contract, then, settles three business days prior to the 25th of the month. So just in case the 25th is a non-trading day, either a weekend day or a holiday, the settlement occurs three business days prior to the business day that is prior to the business day ahead of the 25th. I know that sounds very confusing. I can't quite figure it out myself half the time.

Margin requirements. This is a big issue here. You can see that if you want to buy or sell crude oil contracts, for every single contract that you wish to enter into, you have to have $5,100 in a margin account. That's a safety net against losses that you could incur. This protects your clearing broker and protects the New York Mercantile Exchange from default by you as a counterparty.

This also discourages a lot of traders from just jumping in and trying to trade contracts. For example, if a trader wanted to speculate on 10 crude oil contracts-- that's only 10,000 barrels-- that's not a lot of volume, per se. They would have to put $51,000 in a margin account before they could even get started.

Here is the symbol breakdown. When you look at futures screens, or if you see the prices reported in the Wall Street Journal or any other type of publication, you'll see these funny symbols. The first two letters of the symbol represent the energy commodity themselves. So CL represents crude oil. The second letter is the actual month of delivery. For example, U equals September. The final symbol is the number that corresponds to the year. In our example, 2. So the September 2012 contract for crude oil on the NYMEX is expressed as CLU2.

Other symbols that represent energy commodities-- NG for natural gas, HO for heating oil. RBOB represents unleaded gasoline, and then PN for propane. And then here's the breakdown of the symbols that they use. Feel free to use this as a cheat sheet if you ever run across those quotes and can't remember what they mean.

When you look at futures screens, you're going to see column headers that will use these types of terms. When you see the open, that's the opening price at the opening bell. When you see people on television ringing the bell for the open of whatever market it might be-- the stock market, the NYMEX, the Chicago Mercantile Exchange-- as soon as the bell goes off, the very first trade that is consummated, that price is registered as the open for the day.

The high is the highest price that traded that day, including the after-hours electronic trading. The low is the lowest price that traded for that day, including after-hours electronic trading. That gives us the range on the day-- what was the entire range of pricing that day.

When you see last, that's the last trade that just occurred. In other words, what was the last trade that had occurred? The net would be the change in price from that last trade to the one prior to it. So are we going up or are we going down as we're trading currently? And then change-- the change is the change in price from the trade that just occurred, from that last trade, versus the prior day's settlement. What was the final price for the energy commodity the day before, and where do we sit relative to that today? That's what change represents.

We refer to futures contract trading as a zero-sum game. For every buyer, there is a seller. I can't buy crude oil contracts without someone being willing to sell them to me, nor can I sell them without a market. And believe it or not, less than 2% of all the contracts traded actually go to physical delivery. In other words, less than 2% of the contracts will actually be energy commodities exchanged between counterparties. Now, on the one hand, that may sound like a small number, but with each crude oil contract representing 1,000 barrels, and you can trade between 50,000 and 100,000 contracts a day, it does amount to a substantial amount of physical energy commodities being exchanged.

This is what a typical futures screen would look like. These are the headers that I mentioned to you. On the day that I printed this off, you can see the last trade was $92.68 and, represented a drop of $0.19 from the prior day's settle of $92.87 in the far right corner there. We had the opening price of $93.25, and a high and low on the day as well. And the very far right column is the time at which the trade occurred.

Natural gas futures contracts. The contract unit is 10,000 MMBtus-- that is, 10,000 million British thermal units. Prices are quoted in US dollars and cents, and the minimum fluctuation between trades has to be 1/10 of a penny or what we refer to as a tick. Trading hours are exactly the same, but the trading months for natural gas-- you can actually trade natural gas out 12 years if there was, in fact, a need to buy or sell for that long of a period of time.

Last trading day for natural gas contracts, the futures, is the third business day prior to the first calendar day of the delivery month. We do trade options in energy futures contracts. In the case of natural gas, those expire one day prior to the actual contract itself.

The delivery point for buying and selling under NYMEX natural gas contracts is a place known as the Henry Hub in Erath, Louisiana. Texaco has their Henry plant in Erath, Louisiana. Sabine Pipeline Company runs the hub on behalf of the New York Mercantile Exchange. And again, the delivery period is to be uniform across the month of production for which the contracts were exchanged.

This is a schematic of the pipelines going in and out of the Henry Hub. There are various sources of natural gas coming offshore, onshore. There is gas moving to the Northeast, the Southeast, the Upper Midwest, as well as from Louisiana back into Texas. So it made an ideal market hub for indicating various supply and demand.

Settlement price. Every day, the New York Mercantile Exchange will put together a final price for that day's trading. The settlement price is the weighted average of all the trades that occur during the last two minutes of trading in that regular session. Now, when the closest future month, or what we call the prompt month, when that contract expires, they're going to take the total number of trades in the last 30 minutes to come up with a weighted average, and that will be the price for that month. And that month rolls off, as we say, and it's in the history books.

Margin requirements for natural gas are substantially less than crude oil, but the value is substantially less, so there's only $2,100 margin requirement per contract.

This is what a natural gas futures screen would look like. If you ever see one of these on a trading floor or somewhere else, perhaps on someone's screen who trades in these contracts, this is what it would look like.

We're now going to talk about unleaded gasoline, referred to as RBOB. RBOB stands for Reformulated Blend for Oxygenated Blending. What we get at the gas pump-- you usually have the opportunity to get 100% unleaded in very few places. Mostly, it's a 90/10-- that is, it's 90% gasoline, 10% ethanol or some other type of blending component. In some cases, you hear about E85, which is 85% unleaded, 15% of some other additive, normally something like ethanol.

So what's traded on the New York Mercantile Exchange is actually the 100% unleaded. It becomes a feedstock for unleaded because it's only 90% of what we get at the pump unless we're buying 100% unleaded. So it's reformulated blend for oxygenated blending. They're going to blend oxygenators into the unleaded gasoline.

The oxygenators are seasonal in nature, depending on the regions. Again, oxygenators help to burn the gasoline more efficiently and therefore reduce the emissions. Oxygenators are things such as ethane, ethanol, butane, isobutane, and natural gasolines.

Every RBOB contract is 42,000 gallons. US dollars and cents, and the minimum fluctuation is 1/1000 of a penny per gallon. The delivery point is free onboard or delivered into the petroleum products terminals in New York Harbor. Margin requirements-- $8,100 per contract.

Last but not least, heating oil, or HO. It's sometimes referred to as number two fuel oil. Every contract is 42,000 gallons. We are still dealing with US dollars and cents per barrel. Minimum price fluctuation is 1/1000 of a penny per gallon. The delivery point is the same as for RBOB, and that is free onboard or delivered to the petroleum products terminals in New York Harbor. Everything else pretty much remains the same under the standardized NYMEX contracts.

Credit: Tom Seng - John A. Dutton e-Education Institute

NOTE:

The lecture notes can be found in the Lesson 3 module in Canvas (Lesson 3: The New York Mercantile Exchange (NYMEX) & Energy Contracts.)

Optional Material

Trading Pit Hand Signals

As explained in the video, “ask” is a motion to sell and “bid” is a motion to buy at a specific price. We use the word motion because the traders use hand signals to communicate to one another across the pits. The following video illustrates some of these hand signals. Please watch the 3:37 minute video, Trading Pit Hand Signals [13] below.

A guide to open outcry arbitrage hand signals
Click for a transcript.

Many of Chicago’s “open outcry” trading pits are closing this month. This form of trading was born in Chicago, centered around traders shouting orders to brokers. Eventually, it got so loud a sign language developed in the pits.

PRESENTER 1: If you've ever seen Ferris Bueller's Day Off, when he's up there and they're making all those signs, this was a way for traders to communicate with other traders, with other brokers, with other order fillers.

PRESENTER 2: It's loud, crazy on the floor, and you need to communicate very simply.

PRESENTER 3: There's so much noise that if I said "buy 20" or whatever, they can't hear. So, I have to have some type of a symbol that shows.

PRESENTER 4: Let me get a sight line to a guy. And I'll say, buy 10 (pointer finger pointed at forehead and then quickly moved away from head). And then this guy will tell the broker, buy 10.

So we'll have a guy standing next to the broker. We'll have a guy on the phone. The customer will tell me what he wants to do, and I'll have it flashed in (using a hand signal for buy 10) -- way faster. And it cuts out all the nonsense.

PRESENTER 1: If you wanted to say, buy 100 S&Ps at the market, you would go, buy 100 (fist on forehead). And you'd go like this with your hand (slash hand in front of you, palm down), and that would mean market.

PRESENTER 2: If you're buying, you have your palms in, just like you're grabbing something toward you. If you're selling, you're pushing something away.

PRESENTER 4: We were in the S&P, so they had dimes and nickels. So it was 10 bid (pointer finger up, palm toward you), 15 bid (pointer finger bent at knuckle, palm toward you), 20 bid (pointer and middle fingers up, palm toward you), quarter bid (pointer and middle fingers bent at knuckle, palm toward you), 30 bid-- I'm sorry, 30 bid (pinky, ring and middle fingers up, palm towards you), 35 bid (pinky, ring and middle fingers bent at knuckles, palm towards you), half (all 5 fingers up, facing towards you), doubles (all five fingers bend at knuckles, facing towards you) -- even money (fist pointing towards you).

PRESENTER 5: It could be one (pointer finger up pointing away from you). I mean, naturally, you go right up to one. Or it could be five (all five fingers up pointing away from you), or you could do this, 10 (both hands facing out with all fingers up). This could be 100 (fist on forehead facing out and pushing away from your head).

PRESENTER 3: Now, you're usually holding your deck in the other hand. Your pencil may be in this hand, so you're giving your symbols. But you have your deck or your card, your trading cards, in this hand.

So you don't have two hands to go six or seven. So what we would do is turn a hand sideways. So now this becomes six (pointer finger pointing to the right, palm towards you), seven (pointer and middle fingers pointing to the right, palm towards you), eight (pinky, ring and middle fingers pointing to the right, palm towards you), nine (four fingers pointing to the right, palms towards you).

PRESENTER 2: And then as you go up to 10 (right-hand pointer finger touching forehead), 20 (right hand pointer and middle fingers touching forehead), 30 (right hand pinky, ring and middle finger touching forehead), 40 (right hand four fingers touching forehead), 50 (right hand palm open touching forehead) --

PRESENTER 1: 60 (left-hand pointer finger touching forehead), 70 (left-hand pointer and middle fingers touching forehead), 80 (left-hand pinky, ring, and middle finger touching forehead), 90 (left hand four fingers touching forehead), and 100 (left fist touching forehead).

PRESENTER 3: And later when the big trades came in and the options and the Eurodollars, they even came out with 1,000, which was the crossed hands (fists) in front of your chest.

PRESENTER 2: And then you really want to make a statement on the trading floor, you're going 1,000 (arms crossed in front of you, left with fist, right with pointer finger out), 2,000 (arms crossed in front of you, left with fist, right with pointer and middle fingers out), 3,000 (arms crossed in front of you, left with fist, right with pinky, pointer and middle fingers out).

PRESENTER 4: It's way faster and way easier to do. And you can put orders into different areas, too. You could look at a guy to the right of you. If he wasn't paying attention, maybe the guy next to you would. So create a competition, too, amongst brokers and clerks.

PRESENTER 2: One ear is listening to the marketplace. The other part of your brain is having a conversation, and you're not missing a cue. That's amazing to me.

So I thought this would be just really a good life skill to have. You're in the grocery store. Instead of yelling the amount-- hey, just get five, just five-- no, it doesn't work.

PRESENTER 4: You're out (wave a hand in front of your neck a few times). That was another good one.

PRESENTER 1: Or he'll go like this to a bartender. I need three more beers.

PRESENTER 4: Right.

PRESENTER 5: Or out.

PRESENTER 1: Out.

PRESENTER 5: Out.

[INTERPOSING VOICES]

PRESENTER 1: Cut off. I'm cut off.

PRESENTER 4: [LAUGHING] Right.

PRESENTER 3: Yeah, I always thought that was quite ridiculous. I see these guys going to the bar and says, yeah, cost me $20. I'm thinking you got to-- the same guys that used to go into the bar with their trading jackets on. [LAUGHING] I mean, I always thought that was a little hokey. But no, I never did use the hand signals.

MAN 1: 186.9 halves.

MAN 2: Two dollars. Three or four, all you want.

MAN 3: Cut!

PRESENTER 5: I would try most of the time not to even use the hand signal.

Source: WBEZ

NYMEX Order Flow

All orders placed on the NYMEX to buy or sell contracts are done in a very precise manner with each party involved fully aware of the details of the transaction. As legally-binding agreements, non-performance under a futures contract can have severe financial and legal consequences. Therefore, most phone conversations are taped to ensure the accuracy of the orders placed as well as the results of the execution of those orders. Standardized order forms are used during order execution and daily "check-outs" occur between brokers and their clients for verification of all trades conducted that day. In this section, we will follow a natural gas futures contract trade from the beginning to end for a producer and end-user wishing to lock-in a fixed price for a 12-month period.

Key Learning Points for the Mini-Lecture: NYMEX Order Flow

While watching the mini-lecture, keep in mind the following key points and questions:

  • All orders must be placed with a “clearing” broker who guarantees the trades.
  • Contracts can be used for pure trading or “hedging” physical and price risks.
  • Energy Trading companies & Financial Brokers provide risk services to their customers.
  • Orders flow from customer’s representative through the financial trading process.
  • Orders with NYMEX can be filled via the traditional “pit” trading or electronic platforms.
  • Less than 2% of all contracts traded ever become physical transactions.
  • Trading is a “zero-sum” game. For every winner, there is a loser (there are two sides to every trade).

NYMEX Order Flow Lecture

The following video is 10:40 minutes long.

EBF 301 NYMEX Order Flow
Click for a transcript.

As mentioned in the introduction to this lecture, we're going to walk through the specific steps of executing a buy and sell order on the floor of the New York Mercantile Exchange. We're going to be doing this during the regular session where there are active traders in the pits doing what they call the open outcry trading. In order to understand what's going on, there are two key terms here that we're going to need to understand.

One is a bid. And it's a motion to buy a futures contract at a specified price. The opposite of that is an offer. Again, a motion to sell a futures contract at a specific price. And that's also known as the asking price. And we use the word motion because the traders are using various hand signals to communicate to one another across the pits, if they're buyers or sellers, what volume, and what price.

So the example we're going to use in this case is a 12-month price, a 12-month "strip" average of $3.50. As mentioned in Lesson Seven, you can go out and you can buy or sell contracts at an average price as opposed to having to buy or sell at each individual month's price. In this case, we're looking at 12 months out. So currently, this 12-month strip is running $3.50. And there's a producer out there who would like to lock this price in, or better, if he or she can get that. So the producer's going to call a trader at the energy company and tell them that they're interested.

So the trader will turn around then and they'll ask the personnel on the fixed price desk to call New York and find out where the market currently is, where are the bids, where are the offers, for this 12- month strip for natural gas. Energy trading companies that have financial derivative trading, they will have a fixed price desk. These are the personnel mostly responsible for dealing with the New York Mercantile Exchange.

So the fixed price desk calls their broker on the floor of the New York Mercantile Exchange to find out the current market quotes and both the bid and offers. Now the person that they're talking to is the clearing broker and, specifically, the phone clerk. If you recall the picture of the floor of the Mercantile Exchange from Lesson Seven, you can picture those phone banks. So this is where that phone call is going to.

The fixed price desk person turns around then and gives the trader the current market quote. The producer then gets that bid and offer from the trader. And given that the market is still in the $3.50 range, the producer decides that he or she would like to lock in the price of $3.50 or better for the next 12 months if in fact it can be executed. The trader now takes the order from the producer and passes it along to the fixed price desk.

Now, at this point in time, the producer is obligated to perform under this contract. In other words, the producer realizes that the energy trading company's going to have to enter into the legally binding contracts on the New York Mercantile Exchange to obtain this fixed price for them. So the producer is going to have to perform by giving the physical gas when the time comes to the energy trading company.

So, the trader gives that order, the sell order, to the fixed price desk. The fixed price desk then calls New York again and, tells the phone clerk with the clearing broker on the floor of the NYMEX that they would like to sell the one month strip $3.50. The phone clerk immediately stamps the ticket that they have, indicating when the order was received from the fixed price desk at the energy trading company.

The phone clerk will then walk over to the pits and hand a copy of that ticket to their broker who is trading in the pits themselves. That pit broker then offers out the 12-month strip into the market at $3.50. Another broker, who has received a buy order from another customer, decides to go ahead and lift the offer on the 12-month strip at $3.50. So keep in mind that, as we mentioned in the prior lesson, it's a zero-sum game. For every buyer, there is a seller.

So, in this case, the producer is having the trading company sell contracts for them. There has to be a buyer across the pit willing to buy those contracts in order for the deal to be consummated. So in this case, there happened to be an interested party on the other hand. And for our purposes, we'll go ahead and assume that it's an end user who's interested in buying the natural gas at $3.50 for the next 12 months.

So, once the counterparty across the pit has gone ahead and lifted the order, the broker now hands the order back to their phone clerk. And the pit brokers also then have an official form that they have to fill out for the New York Mercantile Exchange, which includes the details of the transaction. So the phone clerk now time stamps the ticket, as in they've had it timestamped when the order was received, and it again is stamped with the time when the order is actually filled.

So, phone clerk calls the trader's fixed price desk. The trader's fixed price desk receives the fill from the floor of the NYMEX and repeats the fill verbally to ensure that there's no error. So the clearing broker phone clerk and the trading company's fixed price desk repeat the details of the transaction so that there's no mistake as to exactly what has occurred. And as mentioned in the prior lesson, the phones are also recorded.

So, if there's any dispute at the end of the day when it comes to checking out the trades between the energy trading company and their broker, they can pull the tapes, as we say, if there's a discrepancy and have it resolved that way. OK. The fixed price desk, now having confirmed the order, passes along the fill to the trader. The trader now passes along the completed order to the producer.

So, the producer has gotten done what the producer wanted. So the producer is now what we call hedged if natural gas prices decline below $3.50 over the next 12 months. So they can't get a price any lower than $3.50. However, because of that, they give up any upside. In other words, the producer you cannot get a price higher if the market does move up. But in this situation, the producer liked $3.50. And they wanted to make sure that prices didn't fall on them.

Here are some more terms that are frequently used in terms of New York Mercantile Exchange trading. We already covered the ask and the bid. A bull, a lot of you have already heard this term. But it's actually someone. It's a person who anticipates an increase in price or an increase in volatility. (Volatility is a measure in the magnitude of price change, as well as the frequency of the change in price). And they are the opposite of a bear. A bear, again, is a person who anticipates a decline in price or volatility. And they are the opposite of a bull.

Backwardation. It's a market situation in which the futures prices are lower in each succeeding delivery. It's also known as an inverted market. It's the opposite of contango. So let's take, for instance, the September crude oil contract. If right now it was the highest price, and October was lower than September, and November was lower than October, and so forth, we would have a backward- dated market. Because the normal situation is, the prompt month or near month, and for several months going out, prices do rise.

A broker. A broker is a party or company which is paid a fee for transactions in the financial and physical markets. Brokers do not take title to the contracts. They do not take title to the commodity being traded. They simply join counterparties together and they extract a fee for doing so. They are truly middlemen. The cash market is the market for a cash commodity where the actual physical product is traded.

So, we've mentioned a couple of times, we differentiate between financial and physical or cash marketplaces. When I talked about the pricing publications, they cover the cash market. The CFTC, that's the Commodity Futures Trading Commission. This is the federal agency responsible for the oversight of all commodities trading, not just energy commodities. The contango market. This is the opposite of the backward dated market. It's a market situation which the prices are higher in succeeding delivery months than in the prompt month.

To cover. We use that term to talk about a trader or company who happens to be short futures or options positions. In other words, they've sold contracts in anticipation of prices falling. And so that open position is known as a short position until such time as they buy those contracts back and cover that open position. A derivative is a financial instrument derived from a cash market commodity, a futures contract, or other financial instruments.

The New York Mercantile Exchange contract for natural gas is derived from natural gas itself, the commodity. And the same applies to the other energy commodities on the NYMEX. The last trading day. It's the last day of trading for the prompt month contract. Currently, for natural gas, it's three working days prior to the next calendar month. We covered the deadlines for each of these in Lesson seven.

Long. This is a market position based on owning contracts which must be sold, or the delivery of the underlying commodity must be accepted. It's the opposite of short. So a trader or a company who takes a long position, they're buying contracts in anticipation of prices rising. And then they will sell those contracts hopefully at a profit. The offer, we mentioned already. We talked about what an offer is.

Open outcry is the name given to the pit trading. OK. For NYMEX purposes, it's a method of public auction for making verbal bids and offers for contracts in the trading pits or trading rings of commodity exchanges. It is totally different than electronic trading platforms. The short. This is a market position based on selling contracts which must be brought back or the delivery of the underlying commodity must be made. It is the opposite of long.

So again, this is where traders are selling contracts in anticipation of prices falling. They'll buy them back and make a profit. We mentioned earlier the idea that when they are short, they'll have to cover those positions by buying the contracts back. Strike price. We will get more into this when we talk about options. But it's the price at which the underlying futures contract is bought or sold in the event that an option is exercised. It's also called an exercise price.

John A. Dutton e-Education Institute
NOTE: The lecture slides can be found in Module 3 in Canvas (Lesson 3: The New York Mercantile Exchange (NYMEX) & Energy Contracts)

Optional Materials

High-Frequency Trading

"High Frequency Traders" (HFT) are impacting the market in a huge way by using super-computers to execute high volumes in nano-seconds. To get an explanation of HFT and their impact on the market, view this video (2:29 minutes).

How High-Frequency & Algorithmic Trading open the Floor for a Flash Crash
Click for a transcript.

SPEAKER 1: The problem with high-frequency trading is this. First of all, it's a myth that it hurts the common trader. Somebody that's on E-Trade and wants to buy IBM or some other trade isn't buying it for the nanosecond. They're not worried about that microsecond that they might have gotten and one-hundredth of a penny difference.

If you're an average trader, and you're worried about one-hundredth of a penny, you shouldn't be trading because you can't compete with the big boys. It's just not going to happen. So, most people-- public-- they trade. They buy something. They hold.

And they're looking for a few points or a long-term investment. So, the high-frequency traders really, I agree-- that don't affect them. Where the high-frequency traders affect everybody, and this is where you have what they call the flash crash. And I didn't really look at it as a flash crash.

I looked at it as that it was a vacuum, and some people say it's the same thing. Well, it's really not. When we were in the pit and news would come out, and all of a sudden want to be like 60 bid at 60, at 40, at 20, at even-- there'll be some person like me saying, OK, I'm 95 bid, and they go sold. There'll be another person that'll go 90. Then it will be sold.

And if somebody would come out 85 bid, it will be sold. So, there will be natural stops in the market. Natural volume because with 200 people in the pit, you have 200 different opinions. And everybody either had an opinion-- either it was too sold or too bought.

And the market would have ebb and flow going back and forth. Put in high-frequency trading. They tend to run on the same algorithm program. And when news comes out, they just pull.

SPEAKER 2: Pull out, panic the market drops. Yeah, and that's a real risk.

SPEAKER 1: They can pull out orders in nanoseconds. I can't tell you how many times that news came out, and a broker with 60 bid for 100. And before his clerk could grab him on his neck, I could go sold. OK, you can't do that now with the speed.

And what happens now is that it would be the equivalent of all the locals in the pit, the minute news came out that they would say, we're going to lunch. Have a nice time and see you later. And then the brokers would look.

And I've seen a broker's face when there's no bid when he has to sell something or no offer when he has to buy something. And that's why these vacuums now are just extraordinary. And that is the problem with where the high-frequency trader comes in. No, for 99% of the time, it's actually pretty good that they're there because they're arguing.

They are going back and forth with bids and offers, and I can get into any trade now. You can get into any trader now. Getting out's the problem.

Source: CapitalAccount

Future of the Trading Floor

Please watch the following short video (1:55) about the future of the NYMEX trading floor and how electronic trading is affecting the trading pits.

End of Era: Trading Pits Close
Click for a transcript.

PRESENTER: Even if you've never been to the famed trading pits, chances are, you know what they look like and sound like.

[VIDEO PLAYBACK]

[CROWD ROARING]

- Sell 30 April at 142!

[VIDEO PLAYBACK]

PRESENTER: Featured in films like Trading Places and Ferris Bueller's Day Off, the trading pits at the Chicago Mercantile Exchange were loud and hectic.

[VIDEO PLAYBACK]

[CROWD ROARING]

[END PLAYBACK]

PRESENTER: On July 6th, the futures pit in Chicago and New York, where buying and selling sets the prices for commodities like gold, wheat, and corn, roars one last time. The 167-year-old tradition of open outcry futures operations ends after the closing bell on Monday.

VIRGINIA MCGATHEY: For example, if I'm trying to buy 25 at 4 and a quarter, I would be saying that and also doing the hand signals at the same time. And then the opposite person would be saying, OK, I'm selling you 25 at 4 and quarter. And so, then we'd understand that I was buying and they were selling.

PRESENTER: Virginia McGathey, a grain trader on the Chicago Mercantile Exchange floor, just finished her last shift in the pit. In short, blame the computers. CME Group, which operates the trading pits in New York and Chicago, is shifting to electronic dealing. And CME Group held off on going all digital, even as rivals in New York and London embraced electronic trading.

VIRGINIA MCGATHEY: It's really heartbreaking on a particular level that it's ending this way. And I think, in talking with some of the other traders, the fact that we can't leave a legacy to children and grandchildren, that this is the end of the road-- it's just definitely not the same on a computer, not at all.

PRESENTER: And not all the pits are closing. One exception is the S&P 500 futures market, which remains open on the Chicago trading floor. In another sign of changing times, fans of CME Group can track the company on several social media sites, including Twitter, Facebook, Instagram, and Pinterest.

Source: Wall Street Journal

Lesson 3 Activities

Pricing Activity

The NYMEX is actually owned by the Chicago Mercantile Exchange (CME Group). Visit the NYMEX [9]website. Choose two energy commodity futures contracts (other than crude oil or natural gas) being traded in the NYMEX and report the following:

  • futures contract specifications: can be found in the Contract Specs tab;
  • definition of column headers in the Quotes tab;
  • screenshot of the front (prior) month futures prices;
  • report the "Last," "Change," and "Prior" prices, and also report the volumes for the front month contracts.

Note: To find the energy commodities, go to the NYMEX [9]and follow this path:
Markets -> All Products -> filter Asset Class for Energy or choose one of the products from the Asset Class under the Energy subcategory.

The answers should be uploaded to the L3 Activity dropbox in Canvas as a Word document or PDF.

Grading Criteria

This activity is due at 11:59 pm on Sunday and is worth up to 20 points on the EBF 301 grading scale.


Fundamental Factors Activity

Part of the overall objective of this course is to have you understand how the market functions in terms of determining price and how it trades in general. To truly appreciate this, you have to begin to think like an energy commodities trader. To do so, you must consider the market factors that they research before making any buy/sell decisions.

In Lesson 2, you were presented with a number of “fundamental” factors that can influence the price of crude oil and/or natural gas.

Beginning this week and continuing until further notice, you will submit Fundamental Factors assignments in the respective Lesson in Canvas each week by 11:59 p.m., Eastern US Time, on Sundays. Instructions for the Fundamental Factors assignments [14] can be found under the "Resources" section of this website.

Links to their energy commodity prices (Henry Hub Natural Gas Futures [8] and Light Sweet Crude Oil (WTI) [7]) can be found in the course "Resources" menu on this website and the Lesson 3 Module of Canvas.

You are to submit ALL of the same fundamental factors for both crude and natural gas shown in Lesson 2 and give your opinion on how they impact prices for oil and natural gas. Fundamental Factors assignments should be submitted to the Fundamental Factors Dropbox on Canvas for each week.

Grading Criteria

A detailed grading rubric [14] for the Fundamental Factors activities is available at the bottom of the instructions.

An example of a complete answer would be:

Natural Gas

The Energy Information Agency’s Weekly Natural Gas Storage Report [15] showed an injection of +50 Bcf. This was below the expectation of +60 Bcf, therefore, it was seen as “bullish” since less supply was put into storage implying that demand was higher than expected. Prices would increase under this scenario. Total gas in storage now stands at 1.5 Tcf which is below the 5-year average as well as last year at this time.


Quiz

Return to Canvas to complete the L3 Quiz.

Submitting Your Work

Pricing Activity: Submit your findings as a single Word document or PDF to the L3 Activity Dropbox in Canvas.

Fundamental Factors: Submit your work as a single Word document or PDF to the Lesson 3 Fundamental Factors Dropbox in Canvas.

Quiz: Take the quiz in Canvas.

Summary and Final Tasks

Key Learning Points: Lesson 3

  1. The New York Mercantile Exchange is a market for crude oil, natural gas, heating oil, unleaded gasoline blend-stock, propane, platinum, and palladium.
  2. Futures are legally binding obligations that require delivering or receiving the commodity.
  3. Each contract lists commodity/price/date/location.
  4. The most important function of the Exchange is “price discovery” and transparency.
  5. Each commodity has its own delivery hub.
  6. WTI is the standard crude stream for futures contracts in crude oil.
  7. Only licensed Brokers can trade on the Exchange.
  8. Trades have to be conducted with Clearing Brokers.
  9. There are two classes of market participants, “commercial,” or those interested in the physical commodity, and “non-commercial,” or “speculators.” Commercial entities use the contracts to "hedge" their price and market risk.
  10. Most trading is purely for financial gain, as only a small number of contractual obligations are fulfilled in the physical (cash) markets.

Now that we are familiar with the workings of the Exchange and futures contracts, we will walk through the cash market and its relationship to the financial market in the next lesson.

Activities

  1. Lesson 3 quiz
  2. Fundamental Factors
  3. Lesson 3 NYMEX Pricing Activity

Reminder - Complete all of the Lesson 3 tasks!

You have reached the end of Lesson 3. Double-check the list of requirements on the first page of this lesson to make sure you have completed all of the activities listed there before beginning the next lesson.


Source URL: https://www.e-education.psu.edu/ebf301/node/512

Links
[1] http://onlinelibrary.wiley.com/doi/10.1002/9781119200727.app1/pdf
[2] https://www.investopedia.com/terms/f/futurescontract.asp
[3] https://www.e-education.psu.edu/ebf301/sites/www.e-education.psu.edu.ebf301/files/Transcripts/Lesson3_Transcripts/What%20are%20Futures%20Transcript.docx
[4] http://www.cmegroup.com/company/history/timeline-of-achievements.html
[5] http://www.cmegroup.com/trading/energy/crude-oil/light-sweet-crude_contract_specifications.html
[6] http://www.cmegroup.com/trading/energy/natural-gas/natural-gas_contract_specifications.html
[7] http://www.cmegroup.com/trading/energy/crude-oil/light-sweet-crude.html
[8] http://www.cmegroup.com/trading/energy/natural-gas/natural-gas.html
[9] http://www.cmegroup.com/
[10] https://www.e-education.psu.edu/ebf200/node/192
[11] http://www.futures101.ru/wp-content/uploads/2011/04/nymex-bld.jpg
[12] http://www.energymaxout.com/wp-content/uploads/2013/07/Oil-Trading-and-Speculation.jpg
[13] https://youtu.be/yd31eEEWOoc
[14] https://www.e-education.psu.edu/ebf301/node/680
[15] http://ir.eia.gov/ngs/ngs.html