NYMEX: Dutch Natural Gas (
TTF1!
), Henry Hub Natural Gas (
NG1!
) and WTI Crude Oil (
CL1!
)
Amid a deep energy crisis faced by Europe, Dutch natural gas futures hit a new record of €350 per megawatt hour in August. Governments across the European Union adopted new rules to reduce electricity usage. In just two months, with a dramatic turn of events, natural gas prices in both Europe and the U.S. dipped below zero last week.
TTF Next Hour Contract, which reflects real-time European market conditions, fell to -€15.78 on Monday, October 24th. The Waha index — a main indicator of natural gas supplies in the Permian Basin in West Texas, dropped to -54¢/mmBtu on the same day.
What has made the highly sought-after energy source worthless?
Europe: LNG Overflow and Insufficient Storage
TTF contracts are for physical delivery of natural gas through the transfer of rights at the Title Transfer Facility (TTF) Virtual Trading Point, operated by Gasunie Transport Services (GTS), the transmission system operator in the Netherlands.
Due to sanctions on Russia, European countries have been buying natural gas globally to prepare for peak winter consumption and asked the public to conserve energy. With increase in gas supply and decrease in gas usage, their efforts paid off. The average gas storage level in the EU has reached 93.4% of capacity, and the storage level in Germany has reached 97.5%.
In addition to near-full storage levels, many LNG tankers are heading to Europe. According to Marine Traffic, out of the 641 liquefied natural gas (LNG) carriers in operation worldwide, sixty are already in the north-west Europe, the Mediterranean Sea, and the Iberian Peninsula. Many LNG ships sit idly outside of ports because they cannot be unloaded.
Clarksons Securities estimated that the voyage cost of an LNG carrier runs between $276,700 to $313,000 per day. This amounts to $8.3 - $9.4 million a month. In order to stop the bleeding, sellers are so desperate that they would pay someone to take over the shipment.
US: Overloaded Pipelines Due to Planned Repairs
Waha Index Futures is based upon the mathematical result of subtracting the monthly price published by Inside FERC from the average of the daily prices published by Gas Daily.
Permian gas is produced mainly in the form of associated gas, a by-product from crude oil drilling. Crude production from the prolific basin has hit record highs this year, topping 5.4 million barrels per day in October, according to the Energy Information Administration (EIA).
Natural gas pipelines in the Permian Basin of West Texas cannot operate normally as they are already fully loaded, and natural gas can only be stockpiled in the Permian Basin.
Planned repairs on Kinder Morgan's Gulf Coast Express (GCX) pipeline appear to be the tipping point for the negative prices. Flows on GCX were cut by 38% through October 28th. The constraints forced Permian producers to sell gas at wider discounts to the US benchmark, Henry Hub. Spot prices turned negative on October 24th, meaning sellers have to pay buyers to move the gas.
Bogeyman in Physical Delivery
Specifications for futures contracts are very specific (hence the name). Exchanges strive to include all possible scenarios in contract design. With respect to the most important features, namely, the grade of the underlying commodity and the methods of trade settlement, no alternations are allowed unless they are specifically spelled out in the Rules Book.
Both TTF and Waha reflect spot prices of natural gas physically delivered to the contract-specified locations. These designs worked well at normal times. However, under extreme conditions, sellers could not make delivery due to insufficient storage or overloaded pipelines.
Negative pricing is the bogeyman in TTF and Waha. This bizarre phenomenon is a lesser evil for sellers, who have to choose between taking a known loss and potentially bigger exposure with holding unfulfilled financial obligations.
How did we get here? In recent years, as developed countries are fully committed to combatting global warming, new investments are flowing into renewable energy, and away from traditional fossil fuel such as oil, gas and coal. As a result, gas pipelines and storage facilities are underfunded and lacking maintenance and upgrades. This year’s geopolitical crisis exposed the risk of getting rid of “dirty energy” too soon before clean energy picks up its pace.
TTF Next Hour contract serves as a risk management tool for high-frequency gas traders. The benchmark for European natural gas is actually the TTF Calendar Month Futures. It never turned negative and is quoted at €139 on October 28th.
The benchmark for US natural gas is not Waha Index, but NYMEX Henry Hub (NG). It peaked at $9.70/MMBtu in August and is trading at $5.625 on October 30th.
Remember the Negative Oil Prices?
On April 20, 2020, the front-month May 2020 WTI crude contract (
CL1!
) dropped by 306%, or $55.90, for the session, to settle at negative $37.63 a barrel on the New York Mercantile Exchange.
WTI first came to the market in 1983. It was the most successful futures contract in the history of NYMEX. Each contract calls for physical delivery of 1,000 barrels of crude oil at any storage facility in Cushing, Oklahoma. In the next 30+ years, the exponential growth in WTI trading has outgrown the capacity in Cushing.
In April 2020, all storage facilities eligible to take delivery were completely full. Sellers had to pay buyers to take the crude oil shipment off their hands. That was the first time a futures contract closed at a negative value.
We could see the same bogeyman at play in TTF and Waha.
How to Avoid Getting Caught in Negative Prices
Unless you are a commercial trader who could make delivery, take delivery, and store shipment, it is highly risky to hold any open positions (long or short) during a contract expiration month.
Futures contracts have two methods of final settlement – physical delivery and cash settlement. All financial futures are cash settled. These include equity indexes, interest rates, foreign exchange, and cryptocurrency futures.
Commodities futures, including energy, metals, and agricultural commodities, are a mixed bag. They were all deliverable contracts at the beginning. Newer contracts have adopted cash settlement with the help of cash price index, such as CME Lean Hog Futures.
Despite the methods of delivery, be it physical delivery or cash settlement, closing out the positions before expiration month is a prudent strategy. Doing so will also avoid getting caught in the depletion of liquidity. Commodity market liquidity is usually rolled over to the next contract month well before expiration date.
Happy trick-or-treating !
*Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.
CME Real-time Market Data help identify trade set-ups and express my market views. If you have futures in your trading portfolio, check out on CME Group data plans in TradingView that suit your trading needs www.tradingview.com/gopro/
TTF1!
), Henry Hub Natural Gas (
NG1!
) and WTI Crude Oil (
CL1!
) Amid a deep energy crisis faced by Europe, Dutch natural gas futures hit a new record of €350 per megawatt hour in August. Governments across the European Union adopted new rules to reduce electricity usage. In just two months, with a dramatic turn of events, natural gas prices in both Europe and the U.S. dipped below zero last week.
TTF Next Hour Contract, which reflects real-time European market conditions, fell to -€15.78 on Monday, October 24th. The Waha index — a main indicator of natural gas supplies in the Permian Basin in West Texas, dropped to -54¢/mmBtu on the same day.
What has made the highly sought-after energy source worthless?
Europe: LNG Overflow and Insufficient Storage
TTF contracts are for physical delivery of natural gas through the transfer of rights at the Title Transfer Facility (TTF) Virtual Trading Point, operated by Gasunie Transport Services (GTS), the transmission system operator in the Netherlands.
Due to sanctions on Russia, European countries have been buying natural gas globally to prepare for peak winter consumption and asked the public to conserve energy. With increase in gas supply and decrease in gas usage, their efforts paid off. The average gas storage level in the EU has reached 93.4% of capacity, and the storage level in Germany has reached 97.5%.
In addition to near-full storage levels, many LNG tankers are heading to Europe. According to Marine Traffic, out of the 641 liquefied natural gas (LNG) carriers in operation worldwide, sixty are already in the north-west Europe, the Mediterranean Sea, and the Iberian Peninsula. Many LNG ships sit idly outside of ports because they cannot be unloaded.
Clarksons Securities estimated that the voyage cost of an LNG carrier runs between $276,700 to $313,000 per day. This amounts to $8.3 - $9.4 million a month. In order to stop the bleeding, sellers are so desperate that they would pay someone to take over the shipment.
US: Overloaded Pipelines Due to Planned Repairs
Waha Index Futures is based upon the mathematical result of subtracting the monthly price published by Inside FERC from the average of the daily prices published by Gas Daily.
Permian gas is produced mainly in the form of associated gas, a by-product from crude oil drilling. Crude production from the prolific basin has hit record highs this year, topping 5.4 million barrels per day in October, according to the Energy Information Administration (EIA).
Natural gas pipelines in the Permian Basin of West Texas cannot operate normally as they are already fully loaded, and natural gas can only be stockpiled in the Permian Basin.
Planned repairs on Kinder Morgan's Gulf Coast Express (GCX) pipeline appear to be the tipping point for the negative prices. Flows on GCX were cut by 38% through October 28th. The constraints forced Permian producers to sell gas at wider discounts to the US benchmark, Henry Hub. Spot prices turned negative on October 24th, meaning sellers have to pay buyers to move the gas.
Bogeyman in Physical Delivery
Specifications for futures contracts are very specific (hence the name). Exchanges strive to include all possible scenarios in contract design. With respect to the most important features, namely, the grade of the underlying commodity and the methods of trade settlement, no alternations are allowed unless they are specifically spelled out in the Rules Book.
Both TTF and Waha reflect spot prices of natural gas physically delivered to the contract-specified locations. These designs worked well at normal times. However, under extreme conditions, sellers could not make delivery due to insufficient storage or overloaded pipelines.
Negative pricing is the bogeyman in TTF and Waha. This bizarre phenomenon is a lesser evil for sellers, who have to choose between taking a known loss and potentially bigger exposure with holding unfulfilled financial obligations.
How did we get here? In recent years, as developed countries are fully committed to combatting global warming, new investments are flowing into renewable energy, and away from traditional fossil fuel such as oil, gas and coal. As a result, gas pipelines and storage facilities are underfunded and lacking maintenance and upgrades. This year’s geopolitical crisis exposed the risk of getting rid of “dirty energy” too soon before clean energy picks up its pace.
TTF Next Hour contract serves as a risk management tool for high-frequency gas traders. The benchmark for European natural gas is actually the TTF Calendar Month Futures. It never turned negative and is quoted at €139 on October 28th.
The benchmark for US natural gas is not Waha Index, but NYMEX Henry Hub (NG). It peaked at $9.70/MMBtu in August and is trading at $5.625 on October 30th.
Remember the Negative Oil Prices?
On April 20, 2020, the front-month May 2020 WTI crude contract (
CL1!
) dropped by 306%, or $55.90, for the session, to settle at negative $37.63 a barrel on the New York Mercantile Exchange.
WTI first came to the market in 1983. It was the most successful futures contract in the history of NYMEX. Each contract calls for physical delivery of 1,000 barrels of crude oil at any storage facility in Cushing, Oklahoma. In the next 30+ years, the exponential growth in WTI trading has outgrown the capacity in Cushing.
In April 2020, all storage facilities eligible to take delivery were completely full. Sellers had to pay buyers to take the crude oil shipment off their hands. That was the first time a futures contract closed at a negative value.
We could see the same bogeyman at play in TTF and Waha.
How to Avoid Getting Caught in Negative Prices
Unless you are a commercial trader who could make delivery, take delivery, and store shipment, it is highly risky to hold any open positions (long or short) during a contract expiration month.
Futures contracts have two methods of final settlement – physical delivery and cash settlement. All financial futures are cash settled. These include equity indexes, interest rates, foreign exchange, and cryptocurrency futures.
Commodities futures, including energy, metals, and agricultural commodities, are a mixed bag. They were all deliverable contracts at the beginning. Newer contracts have adopted cash settlement with the help of cash price index, such as CME Lean Hog Futures.
Despite the methods of delivery, be it physical delivery or cash settlement, closing out the positions before expiration month is a prudent strategy. Doing so will also avoid getting caught in the depletion of liquidity. Commodity market liquidity is usually rolled over to the next contract month well before expiration date.
Happy trick-or-treating !
*Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.
CME Real-time Market Data help identify trade set-ups and express my market views. If you have futures in your trading portfolio, check out on CME Group data plans in TradingView that suit your trading needs www.tradingview.com/gopro/
Jim W. Huang, CFA
jimwenhuang@gmail.com
jimwenhuang@gmail.com
