Crude Oil and Natural Gas Trading in India

Crude oil is mother of global financial market in general and commodity market in particular as this product contribute greatly to the economic development of the world. A sharp rise in the global crude oil prices lead to higher inflation thereby making the nations to scout for alternate energy sources such as biofuels. Crude oil prices are influenced by the factors such as supply demand, geopolitical tension, weekly oil inventories, trend in international trade, adverse weather condition in the form of hurricanes in the Gulf of Mexico, etc. Amongst the various grades, West Texas Intermediate (WTI) and Brent are two important crude oil grades, which are used across the world extensively. NYMEX is the benchmark exchange for WTI oil while Inter Continental Exchange is the benchmark exchange for Brent oil. 

Natural gas—one of the energy products—is largely traded in the United States and Northern Europe. It is having wide usage in the sectors such as power generation, residential- for heating and cooling, industrial and commercial purposes. The price movement of natural gas are driven by the factors such as supply demand, weather condition in the United States. 

In India, crude oil and natural gas are available for trading in a smaller contract size when compared to their global benchmarks. Both of these contracts are cash settled contracts and no delivery takes place because of logistical challenges. In the following paragraphs, you will get more understanding about trading aspects at a commodity exchange in India.

Table 1: Contract Specifications

* MMBTU - Million Metric British Thermal Units; Source: Multi Commodity Exchange of India

Crude Oil Trading in India

At the MCX, derivative contracts available for trading in crude oil are based on WTI grade for which derivative contract traded at NYMEX WTI oil acts as the benchmark with reference to its price.. The price movement of MCX crude oil is exactly same as that of their global benchmark with price quotation in Indian Rupee. Usually, energy commodities like crude oil and natural gas are in top three traded commodities at the MCX. . 

Since start of trading in commodities at commodity exchanges in India in 2003, , crude oil futures have been  a part of the commodity list. Later on Options  on crude oil futures were introduced in May 2018. Over the period, crude oil options have gained  popularity amongst the investors. In the fiscal 2021-22, volumes in crude oil options have  superseded its  futures contracts.

Following chart depicts month on month growth in the crude oil futures and options. Until July 2021, crude oil futures were higher than the options contract and from August 2021 onwards, the options volumes got more than doubled than their futures contracts. This has been due to an  increased participation by retail traders and also to  the use of  various trading strategies using options. In January and February 2022, the volumes in crude oil options  were higher by 2.4 times than that of futures contract.  

 Source: Multi Commodity Exchange of India

Table 2: Options contract specification

Source; Multi Commodity Exchange of India

Options are one of best derivative products and it could be said that these instruments have  an edge over the futures contracts because of its product nature.  An options contract gives a right to buy or sell  but not an  obligation., . Options require premium amount whereas in futures, margin is payable. Since premium on a given value of a contract is usually lesser than the margin amount on the same value of futures, options are often seen as a low cost derivatives product. It should however be noted that an options are time decaying instrument. . An options buyer or seller can take position in different types of market on the basis of an opinion about the market and devise different strategies i.e. strategies as per bullish, bearish and neutral market.. 

Also Read: How to trade in commodity?

Natural Gas Trading in India

Similar to , the crude oil futures contract, derivative contracts of  natural gas traded at the MCX, takes  cue from its  global benchmark i.e., NYMEX with reference to the price.. During the period from April 2021 to February 2022, natural gas emerged as the second largest commodity in terms of volume  accounting for 24% of total market turnover. Refer Table 1 for a detailed contract specification of natural gas in India. Options trading in Natural Gas was introduced on 17 January 2022 and in the first two months itself, natural gas options clocked a volume of 440 thousand contracts. Refer Table 2 for natural gas options contract specifications.

Energy Index

Another watershed moment in India's commodities derivative trading history was an introduction of commodity-based indices. Energy Index,i.e. ENRGDEX is a blessing in the disguise for commodity investors in India as this index captures the   movement of crude oil and natural gas collectively making it most effective investment tool for retail traders. ENRGDEX is a sectoral index consisting of crude oil and natural gas with a weight of 75% and 25%, respectively. The biggest advantage of ENRGDEX is the requirement of lower margin compared to collective margin on crude oil and natural gas futures, if traded separately.. 

Summary

Energy segment is the second largest turnover generating segment at  commodity exchange, like MCX with a share of approx.. 37% of  the total volume. The price movement of both the energy products, i.e. crude oil and natural gas is derived from their global benchmark contracts traded at NYMEX. For a novice trader, energy products, an energy index, i.e. ENRGDEX Futures is preferred than taking positions directly in a crude oil or natural gas futures. Options could also be another way of participating in energy derivatives.. All the investment products in the energy segment such as Futures, Options and Index are currently cash settled contracts. This facilitates a retail participant to trade in energy derivatives with confidence.

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