Selling (Going Short) Heating Oil Futures to Profit from a Fall in Heating Oil Prices

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Introduction To Trading In Oil Futures

It’s hard to understate how important petroleum is to even the least advanced of modern economies. No substance offers more energy per unit of extraction cost. Abundant and proven, oil will remain the most popular energy source on Earth for some time. With the International Energy Agency projecting 2020 total consumption at 99.2 million barrels a day, oil trades in a sophisticated market with many tools and vehicles for investing or speculating in oil. One way to speculate in oil prices is through trading in oil futures.

Oil futures contracts are simple in theory. They continue the time-honored practice of certain participants in the market selling risk to others who gladly buy it in the hopes of making money. To wit, buyers and sellers establish a price that oil (or soybeans, or gold) will trade at not today, but on some coming date. While no one knows what price oil will be trading at 9 months from now, players in the futures market believe they can. For instance, Commodity X, which currently sells at $30, might be available for $35 in a contract dated to come due next January. A speculator who thinks that the price will shoot past that, say to $45, by said time can thus purchase the $35 contract. Should his prediction be correct, he can then buy X at $35 and immediately sell it for a $10 profit. But should X end up falling short of $35, his contract is worthless. Again, for some investors that futures contract is a way to get a guaranteed price of $35 down the road; for them, better one in the hand than two in the bush, even if X falls to zero. People on the opposite side of the transaction subscribe to another axiom: nothing ventured, nothing gained. Should X shoot to $100 or even $200, the speculator who gambled on X settling at $35 will make several times his investment. The price the commodity in question is expected to sell for on the subsequent date is self-evidently called the “futures” price, and it can differ greatly from today’s price.

Unlike those for most agricultural commodities, futures for oil settle monthly. Cotton futures, for instance, settle 5 times a year. The added frequency and regularity of oil contracts makes it easier for investors to determine trends, or expected trends, in the eventual price of oil. (For more about predicting oil prices see Uncovering Oil and Gas Futures)

As of this writing, oil is trading at $45 a barrel—a 6-year nadir, and almost $100 less than oil prices at their highest. Demand is as consistent and growing as ever, which means that the larger determinant of that lowering price is supply. Increased drilling in the United States has diminished the importance of threats and maneuvering of foreign cartels. Knowing that, what’s a futures investor to do? Assume that prices will continue to fall in the short term, or reason that we’re nearing the point where prices are approaching production costs and thus there’s nowhere to go but up?

Predict the Future through Futures?

As far as answering the question goes, the market has already done the work for us. The next month’s futures contracts are selling for $47.30. The following month’s, $49.02. Then $50.44, then $51.59, and at some point 2 years from now oil prices (or at least, oil prices as predicted by the level of futures contracts) are predicted to break $60 a barrel. Nor does the rise stop there. Beyond the 2-year mark, oil futures settle less semiannually or even annually, rather than monthly. The latest available contract, for 2023, sells for $68.08.

Two things: number one, predicting market movements 8½ years hence is like predicting the weather or the outcome of the Super Bowl that far in advance. The New England Patriots might be in contention in 2023, or they could just as easily go 1-15: the vast majority of the players on that team are unknown quantities, currently playing in college or even high school. The world of 2023 won’t bear a close enough resemblance to 2020 to warrant predictions. Yet the oil futures market for 2023 exists, even though history shows that predicting prices for 8 years forthcoming is a dangerous game.

Only Hindsight is 20/20

To see just how dangerous, let’s see what the futures market of September of 2020 thought oil prices would be in 2020. During that month, December 2020 oil futures were trading for $89. And why not? $89 represented a level close to the then-current $76 a barrel oil was trading at, along with a premium of a few dollars to anticipate the continuation of a rising trend. Makes perfect sense. Except no one, or at least not enough people to make an impact, was predicting that increased production would drive the price of oil down to the levels we’re witnessing in 2020.

Of course, if enough people could have foreseen that, the futures price never would have hit anywhere near $89 in the first place. There are infinite variables that determine the eventual price of oil, but our brains are capable of weighing only the most obvious ones, such as oil’s current price. We can look a month or two in advance with some accuracy, but it’s a straight-up roulette spin to try to figure out what oil will do once four more Olympiads and another presidential election or two have come and gone.

The market offers few guarantees, but here’s one that even Investopedia’s notoriously circumspect legal advisors will stand behind: The actual price of oil will be far more volatile than the relatively tight band of prices indicated by the trends in upcoming futures contracts. A gradual rise to $68.08, with a floor of $45? Don’t bet on it. How can we be so sure? For one thing, the futures trend goes in only one direction. Every change, no matter how incremental, is a positive one. Sure, oil might consistently rise in price over the next 8 years with no drops whatsoever, but it’s never done so in any previous stretch of that length and common sense dictates that it wouldn’t have.

The Bottom Line

To trade in oil futures, you need two characteristics that are often disparate: patience and boldness. You also need a large bankroll to get started. Oil futures contracts aren’t measured in barrels, but rather in thousands of barrels. That December of 2023 future will set you back $68,080, but in return will give you a liquid asset whose value will doubtless fluctuate between now and when it matures. Which means plenty of time to potentially realize a profit, or to wait and wonder if you made a foolish decision. Either way, oil futures trading is not for dilettantes.

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Why Trade Heating Oil? Surprising 1.6% Growth Makes For An Interesting Bet In 2020

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Last Updated on April 2, 2020

3 Reasons You Might Invest in Heating Oil

The best reasons for investing in heating oil include:

How Does Heating Oil Act as a Home or Business Cost Hedge?

Homeowners with high annual heating bills may want to buy heating oil to hedge these expenses.

Businesses that depend on active operations during the winter months, such as restaurants, ski resorts and hotels, may want to buy heating oil to hedge the unpredictable variable cost of heating their properties.

Speculating on Oil Demand

Heating oil investing provides a way to express a bullish view on crude oil.

Investors optimistic about global growth and pessimistic about the supply of fossil fuels available to meet demand may want to invest in heating oil.

As emerging market countries modernize their economies and build more housing and businesses, the need for fuels to power factories and heat buildings will grow. The same supply/demand imbalances that favor crude oil should also benefit heating oil.

Betting on Weak Dollar

A weaker US dollar is generally positive for the entire commodities complex, including heating oil.

Investors who believe that debts and deficits in the United States will pressure the dollar over the long run may want to place some of their investment funds in commodities like heating oil.

Should I Invest in Heating Oil?

Heating Bill Hedge: People who live in cold climates and use heating oil to heat their homes may want to invest in the commodity in advance of the winter months. Using a heating oil investment to protect against the cost of winter utility bills may be a sensible risk mitigation strategy.

Bet on Growth: Investing in heating oil also provides a way to bet on global economic growth. As emerging markets expand, many analysts believe that fossil fuel demand will outstrip supply and lead prices higher. Also, newly developed areas often lack natural gas infrastructure and need heating oil as a source of fuel.

Diversify Your Portfolio: Heating oil may be a viable way to diversify an investment portfolio. Most traders have assets heavily concentrated in equity and fixed income markets. Commodities provide diversification as they generally have low correlations with stocks and bonds.

All investments carry the possibility of losses, so traders should consider the risks of investing in heating oil. Some risks include:

  1. Warmer than average weather could send prices lower.
  2. Strength in the US dollar could produce weakness in commodities prices including heating oil.
  3. Alternative sources of heating and technological advances in insulation materials could depress demand for heating oil.

What Do the Experts Think About Heating Oil?

Most experts agree that the price of heating oil is closely tied to both crude prices and refinery capacity.

In the view of many analysts, growing demand for crude combined with strains on refining capacity could drive heating oil prices higher. Janet Kong, a senior executive with multinational oil company, BP, believes that demand for distillates such as heating oil is driving higher global demand for crude oil. Other analysts concur with this view:

“The big surprise … has been on the distillate side, where it looks like we will hit 1.6 percent growth.”

-Matti Lehmus, vice president of oil products at Neste Oil

Robert Campbell, head of oil products analysis at Energy Aspects, believes that strong demand for refined oil products is incentivizing refineries to increase their output of products.

How Can I Invest in Heating Oil?

Investors have a few direct and indirect ways of investing in heating oil:

Heating Oil Trading Methods Compared

Method of Investing Complexity Rating (1 = easy, 5 = hard) Storage Costs? Security Costs? Expiration Dates? Management Costs? Leverage? Regulated Exchange?
Heating Oil Futures 5 N N Y N Y Y
Heating Oil Options 5 N N Y N Y Y
Heating Oil ETFs 2 N* N N Y N** Y
Heating Oil Shares 2 N N N N Y Y
Heating Oil CFDs 3 N N N N Y Y

*Most energy ETFs invest with futures and avoid storage costs.
**Some energy ETFs offer exposure to 2X or 3X the movement in commodity prices.

Heating Oil Futures

The New York Mercantile Exchange (NYMEX), a commodities and futures exchange operated by the Chicago Mercantile Exchange (CME), offers a heating oil futures contract that settles into 42,000 gallons of heating oil per contract. The contract trades globally on the CME Globex electronic trading platform.

Futures are a derivative instrument through which traders make leveraged bets on commodity prices. If prices decline, traders must deposit additional margin in order to maintain their positions. Heating oil futures contracts expire on the last business day of the month preceding the delivery month. At expiration, traders must either accept physical delivery of heating oil or roll their positions forward to the next trading month. Investing in futures requires a high level of sophistication since factors such as storage costs and interest rates affect pricing.

Heating Oil Options

The NYMEX offers an options contract on heating oil futures. Options are also a derivative instrument that employ leverage to invest in commodities. As with futures, options have an expiration date. However, options also have a strike price, which is the price above which the option finishes in the money.

Options buyers pay a price known as a premium to purchase contracts. An options bet succeeds only if the price of heating oil futures rises above the strike price by an amount greater than the premium paid for the contract. Therefore, options traders must be right about the size and timing of the move in heating oil futures to profit from their trades. Heating oil options contracts expire three business days prior to the expiration of the underlying futures contract.

Heating Oil ETFs

These financial instruments trade as shares on exchanges in the same way that stocks do. There is currently only one pure-play heating oil exchange-traded fund (ETF):

    The United States Diesel-Heating Oil Fund LP –

In addition, there are many ETFs that invest more broadly in the energy sector including these popular funds:

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Shares of Heating Oil Companies

There are many companies engaged in extracting, refining and selling crude oil and crude oil products. While these companies are not pure-play investments in heating oil, the performance of their shares is correlated with crude oil and refined crude products.

Shares of oil companies also react to other factors including the performance of management and the stock market in general.

5 Leading Diversified Oil Companies

Company Current Price Overview Exchange Founded Number of Employees Interesting Fact
BP
Headquartered in London but the USA houses the lion share of its operations. London (LSE),
Frankfurt (FWB),
New York (NYSE) 1908 74,000+ Burmah Oil Company, the company that eventually became BP, was the first to discover oil in the Middle East. ExxonMobil American multinational oil and gas corporation. New York (NYSE) 1999 80,000+ Largest refiner in the world with a capacity of nearly 6m barrels per day. Total S.A. French energy multinational. Paris (CAC),
New York (NYSE),
Amsterdam (Euronext) 1924 100,000+ Total has over 900 subsidiaries covering all areas of energy. Royal Dutch Shell British-Dutch multinational headquartered in The Netherlands. London (LSE),
Amsterdam (Euronext),
New York (NYSE) 1907 90,000+ Shell has over 40,000 service stations worldwide. ConocoPhillips The world’s largest independent pure-play exploration and production company. New York (NYSE) 1875 12,000+ Conoco Inc. and Phillips Petroleum Co. merged in 2002 then in 2020 spun off its downstream assets as Phillips 66.

One way to invest in heating oil is through the use of a contract for difference (CFD) derivative instrument. CFDs allow traders to speculate on heating oil prices without purchasing ETFs, futures, options or shares of oil companies. The value of a CFD is the difference between the price of heating oil at the time of purchase and the current price. CFD traders, therefore, have direct economic exposure to the commodity.

Many regulated brokers worldwide offer CFDs on heating oil. Customers deposit funds with the broker, which serve as margin. The advantage of CFDs is that traders can have exposure to heating oil prices without having to manage complicated futures or options positions.

Plus500 is one of the top brokers in heating oil CFD trading. 76.4% of retail CFD accounts lose money.

76.4% of retail CFD accounts lose money.

Ready to Start Trading Heating Oil?

  • No commission on trades (other charges may apply)
  • Free demo account
  • Easy to use (mobile-friendly) platform
  • Industry-leading risk management tools
  • Trade heating oil and hundreds of other markets
  • Your funds are safe – publicly listed company regulated by the UK’s Financial Conduct Authority and Cyprus’ Securities and Exchange Commission

One of the leading CFD brokers for trading energy commodity CFDs, like heating oil, is Plus 500. Here’s why:

  • No commission on trades (other charges may apply)
  • Free demo account
  • Easy to use (mobile-friendly) platform
  • Industry-leading risk management tools
  • Trade heating oil and hundreds of other CFDs
  • Your funds are safe – publicly listed company regulated by the UK’s Financial Conduct Authority and Cyprus’ Securities and Exchange Commission

Important: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. Between 74-89% of retail trader accounts lose money when trading CFDs. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

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