In this article we will be discussing various energy commodities, namely natural gas, heating oil and gasoline. Natural gas and heating oil can both be categorised as distillate energies, or distillates, whereas natural gas is a commodity extracted by drilling for gas deposits often found alongside crude oil reserves.
What are Energies?
The term energy, when related to trading is a broad term used to describe commodities which can be used as a means of power.
What are Distillates?
Heating oil and gasoline both derive from distillation, which is the process by which crude oil is heated, and the resulting gasses are cooled at specific temperatures. The temperature at which the gasses are cooled will determine which form of energy is produced.
This differs from natural gas, which does not need any distillation and is found naturally underground. It is important to note that all of these resources are finite, and will one day run out.
Heating oil and natural gas are both used to heat homes and buildings. Heating oil, also known as fuel oil or gas oil is a by-product of crude oil. Many homeowners prefer heating oil as their primary heating resource because of the fact that it is safe and are traditionally cheaper than other heating fuels.
In the USA, the largest consumer, approximately 78% of houses in the north-east use heating oil. That equates to around 7.5% of residential homes in the country – a considerable market! The heating oil is burnt in a furnace to generate heat, and it is used in regions where the natural gas infrastructure is not linked to homes or commercial buildings.
Natural gas by comparison is the most commonly used form of heating energy, and is connected to most households directly via pipelines. After it is extracted from the ground, the natural gas must be treated in order to separate it into liquids and gasses suitable for transporting around the world (as liquid), and domestically in pipelines.
It must then be processed in specialist plants to ensure it meets quality specifications. This is an extremely complex and expensive process, and any disruption to the processing will impact upon prices. Natural gas also has other uses besides heating and these include the generation of electricity and cook food via gas ovens.
This means that whereas heating oil will have strong seasonal demand, natural gas will be required consistently throughout the year. It is estimated that up to 25% of American energy consumption comes from natural gas.
Gasoline, also known as petrol, is similar to heating oil in that it is also a by-product of crude oil but is primarily used to power machinery, most notably cars. Gasoline is consumed across the world. It is important to note that there are other distillate markets besides heating oil and gasoline, and these include kerosene, jet oil and diesel, amongst others.
Although these markets are far smaller than gasoline and heating oil, as traders we must also monitor these when trading distillates as they have a very close correlation to one and other.
Supply and Demand Factors
When trading energies we have to remember that prices for heating oil, gasoline, and natural gas are determined by supply and demand factors, and are intrinsically linked to crude oil prices.
The two main distillate energies have a much correlated relationship because the more of one energy that is produced, the less supply there will be of another. This is because if more crude oil is being used to produce gasoline for instance, less crude oil is available to be used for heating oil. This fall in supply should therefore lead to an increase of heating oil prices.
The inverse is also true. If less of one distillate is produced, more is likely to be produced of others. An example can be seen in 2001 in the aftermath of the September 11th terrorist attacks. Because airports were shut, and demand for energies to power the planes fell, distillers decided to distil less jet fuel, and switch to heating oil instead.
This leads to a sudden increase in supply, and a consequent fall in heating oil price. This goes to show that not only are all distillate energies closely related, but they will also have a very close correlation with crude oil prices.
Another factor to consider when trading distillates is seasonal demand. Due to the fact that heating oil is used primarily for heating fuel, it is an incredibly seasonal market and prices are largely dependent upon winter weather.
In particularly severe or cold winters, demand increases, and consequently prices rise. However warmer winters will lead to reduced demand, and lower prices. As such, heating oil traders will pay close attention to weather patterns in order to ascertain potential usage.
Although natural gas is also used as heating fuel, the seasonality of natural gas differs. This is because the demand spikes in the winter when heating is required, but it also rises again in summer months when there is an increase in electrical usage, particularly in the USA, due to air conditioning usage.
Gasoline is also a seasonal market, but it contrasts significantly from the heating oil and natural gas seasons. During the winter when heating oil demand rises, gasoline demand tends to fall. The cold weather tends to discourage people from making long car journeys, therefore needing less petrol.
However, in the summer, when heating oil demand falls, gasoline demand increases due to increased car usage. This inverse correlation is one that all energies traders should be aware of.
Heating oil and gasoline will all be influenced in price by supply and demand factors affecting crude oil. If OPEC announced a production cut, this would mean less crude oil would be available to distil into heating oil or gasoline.
For this reason, distillate prices closely follow crude oil prices and if you are trading distillates you should also be aware of factors which will affect oil prices.
Gasoline tends to be the most expensive of the distilled energies as not only does it cost more to distil and produce but it also has the highest global demand.
As traders the most important supply and demand data for heating oil and gasoline are released alongside crude oil data every Wednesday in the DOE inventories. This is a major market moving economic release as it reveals the stock piles of crude oil, and also other distillate energies.
In a similar fashion to oil, any increase in stockpiles for heating oil or gasoline would lead to a fall in market prices as it indicates a reduction in consumption or an increase in supply. However, a decrease in stockpiles should lead to a rise in prices as it will indicate higher usage or lower supply.
The key supply and demand data for natural gas comes from weekly DOE Natural Gas Storage Reports, released every Thursday. This details the net change in storage levels of natural gas, and this is broken down into three regions – Eastern/Mid-Western areas (the key consumers), the South (which are the main producers), and the West.
- Gasoline and heating oil are by-products of crude oil, formed in the distillation process.
- Natural gas is not a by-product of crude oil, but is commonly found alongside oil reserves.
- Both natural gas and distillates are seasonal markets and they are closely correlated to crude oil prices. As such prices will be influenced by supply and demand factors influencing crude oil prices.
- There is a close correlation amongst all distillate prices as the more demand that there is for one distillate, the less supply there will be for others.
- The key fundamental releases are the weekly DOE inventory figures on Wednesdays and Thursdays which reveals stockpile levels for the distillates and separately for natural gas.