Energy products are varied and have many end uses. Crude oil, for example, can be used to make various refined products, including gasoline, diesel, jet fuel, propane, and fuel oil products. Natural gas can be used for heating applications as well as a feedstock for plastics, chemicals and other applications.
Since energy products can include refined products, which are directly consumed, or raw inputs, like crude oil, which can be made into other petroleum products, the fundamental trader will need to consider the fundamental factors that influence supply and demand for the raw material, as well as supply and demand for the refined products. Traders who trade crude oil will look at all the sources of demand, both foreign and domestic, as well as the demand for refined products.
Energy products, specifically, are very sensitive to changes in supply and demand. Small changes in either can have a noticeable effect on the price of the energy futures contracts. Traders will pay attention to data releases concerning the supply and demand of the energy products they are interested in. For example, a crude oil trader will watch the weekly Energy Information Administration (EIA) inventory reports to remain updated on the current build or drawdown of crude oil in order to build a case of where they believe the price of crude oil will move next.
The main drivers of the price of energy products are user demand, inventory build and drawdown cycles (the supply cycle), and seasonality.
Demand is increased by economic growth along with consumer and industrial demand. If the economy is growing, then energy demand will be higher from both the consumer and industrial sectors.
Some of the factors that create increased demand when economies are growing are: increased demand from the transportation sector, such as automobiles and trucks; increased industrial demand for power consumption requiring increased energy usage; higher heating demand for homes and buildings; and more requirements for energy products that are used as inputs in manufacturing various products, such as plastics and construction materials
Supply, which is reflected in inventory build, also has many factors that make energy unique when compared to other commodities.
Energy products go through what is referred to as a build and drawdown cycle. Some energy products, such are crude oil and natural gas, are extracted from the ground then transported to storage facilities; refined petroleum products are produced by refineries and then stored to be delivered to the ultimate users. This is the build phase.
The drawdown phase is when the product is shipped from the storage facility to the end user. If supply is lower than what is needed to satisfy current demand then there will be a drawdown in inventories, and if supply is higher than the quantity which is being demanded then inventories will increase.
Traders are able to access multiple data sources that provide detailed data on the energy sector, such as weekly data reports published by the EIA, API, and other data services. These reports provide information on stocks, production, refinery utilization, imports/exports, and demand with a detailed breakdown by product and region.
As with all commodities, energy products follow the basic rules for supply and demand. If energy supplies are higher or demand is lower, then prices should decrease. If supplies are lower or demand is higher, then prices should increase. Additionally, a significant oversupply of oil coupled with a drastic reduction in global demand can intensify the downward pressure on oil prices. During times of great uncertainty and volatility, price moves can be substantial. Further, in extreme circumstances, the price of oil can go into negative territory. An example was in April 2020 when supply and storage utilization were high while demand was low, resulting in a negative price for oil.
Seasonality also plays a part in the supply and demand for energy products. There are times during the year when, due to weather, demand might be higher or lower than normal. This might be due to increased demand for heating fuels during winter months, or increased demand for transportation fuels during the summer months when vehicle use is typically higher.
Seasonality effects on energy futures are generally predictable as they occur during the same time each year, but what is not predictable is the actual demand changes during the season.
For example, natural gas goes through a seasonal build to ensure there is enough supply to meet the typically higher demand for heating during the winter generated by lower temperatures. Typically, price fluctuations are based on a combination of actual data and the assumptions that the market makes for price in the future.
Natural gas suppliers will make projections for demand over the coming winter. They will purchase the quantity of gas they believe will be required. If the winter is warmer or colder than anticipated, then actual demand will be different than forecasted demand. It is this difference that can impact the price of the futures contract. If demand is higher than anticipated by the market then price will go up, if it is lower than price will go down.
Traders who trade energy futures need to be aware that there are unique factors that will influence the price of the futures contract they are trading and use fundamental demand and supply analysis to help them analyze the market conditions and make their trading decisions.
Market participants can stay informed on what’s happening in our markets and receive updates through the Subscription Center in CME Group Login and viewing Notices.
© 2020 CME Group Inc. All rights reserved.