If you are a retail energy broker, you must understand how energy futures work. This knowledge is key if you want to give good advice. Here are three things every broker should know about the futures market.
When you look at the history of energy deregulated states and wholesale markets, one thing appears again and again: the energy futures market. It may seem difficult, but it is simply the place where people buy and sell energy today for use later.
Learning this idea is very important if you want to succeed as an energy broker. This guide will explain electricity and natural gas futures. It will also show how these futures affect business customers and what those prices mean inside a retail energy contract.
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What Are Energy Futures and How Do They Work?
In energy trading, futures are common. They are contracts for energy like electricity and natural gas. A futures contract lets a trader agree today on a price for energy that will be delivered in the future. For example, a trader may sign a deal now to buy natural gas six months later at a set price. This agreement between a buyer and a seller in the wholesale market is called a futures contract. In the retail energy market, brokers also use futures in another way. They offer customers fixed prices that start on a future date. Retail suppliers always hedge their purchases in the wholesale market. This means the retail contract is simply a mirror of the futures trade made in wholesale markets.
How Energy Futures Apply to the Energy Broker Market
As an energy broker, when you offer a fixed-rate contract, you must know how that price is created. Electricity and natural gas both have futures markets, just like stocks or other commodities. These markets let people trade energy for delivery at a set time in the future.
This may sound complex, so let’s make it simple. Imagine a natural gas producer. He wants to know what his income will be over the next 12 months. To protect himself, he signs a futures contract with a buyer. The deal says he will sell gas for a fixed price each month, no matter what the market price does.
This is the basic idea of a futures contract. As a broker, you need to understand these contracts well to give strong advice to your customers.
Types of Energy Futures Contracts
In the energy market, there are several types of futures contracts. These include electricity futures, natural gas futures, oil futures, and petroleum futures. In the deregulated retail energy market, the focus is mainly on electricity and natural gas futures.
Electricity Futures Contracts
Electricity futures can trade up to ten years in the future, though most trading happens within the short term, usually less than 12 months. These contracts are traded on major exchanges such as NYMEX and ICE. They are used by customers, electricity marketers, traders, and power producers to hedge costs, plan future revenue, and sometimes make a profit.
- Electricity is different from other energy commodities because it cannot be stored efficiently. When an electricity futures contract expires, the power must either be consumed or the contract closed, resulting in a profit or loss depending on market conditions.
- Retail electricity suppliers use futures contracts to lock in long-term costs. This is especially important when they offer fixed-rate energy contracts to customers. Electricity traders use these contracts to profit from market swings. For example, if they expect prices to rise, they may buy contracts now and sell them later at a higher price. Electricity generators, like power plants, also use futures to secure a steady income. They can sell futures short to profit if market prices drop, which helps offset losses from producing electricity at low costs.
Natural Gas Futures Contracts
Natural gas futures work in a similar way to electricity futures. They can be traded for delivery many years in the future, but most trading happens in the short term. Unlike electricity, natural gas can be stored, so buyers have the option to hold gas until prices rise.
- Retail suppliers use natural gas futures to lock in long-term costs for their customers. When they offer fixed-rate contracts, these futures help guarantee that the gas can be procured at a predictable price. Natural gas producers and drilling companies also use futures. Drilling is expensive, and futures help ensure that the new gas supply will generate a healthy profit. Futures contracts reduce financial risk and make it easier to secure funding for exploration projects.
Turn future insights into smarter procurement strategies.
Key Energy Futures Concepts
Buying or selling energy for the future can be confusing. To understand energy futures, it is important to know the basic ideas first.
Future Months Create Calendar Strips
When energy suppliers offer fixed-rate contracts to customers, they are also making agreements with producers in the wholesale market. These agreements help guarantee the supplier’s costs for the length of the contract. In the futures market, each month has its own price. These monthly prices are averaged together to form calendar strips.
Retail energy suppliers use these calendar strip prices to calculate the costs of a fixed-rate contract. The strips change every trading day as the prices of the monthly contracts move. For example, the 2020–2025 NYMEX natural gas calendar strips show daily price movements between May 7, 2019, and September 24, 2020. You might notice a sharp increase in the 2021 calendar strip around March 2020. This was when the COVID-19 pandemic began, and future energy prices rose quickly.
Understanding how to read and use this data makes you a better energy broker. It helps you know what drives supplier pricing, where prices may go, and how to take advantage of opportunities when market prices dip.
What Are Calendar Strips and Why Do They Matter?
A calendar strip is a series of energy futures contracts for consecutive months within a single year. It is used to represent the average price of energy over a fixed period of time. For example, if a supplier wants to offer a 12-month fixed contract, they will look at the futures price for each of the 12 months.
Then they calculate the average of all those monthly prices. This average is called a strip price. Using this method allows suppliers to create fixed-rate products that reflect the expected wholesale cost of electricity or natural gas. For example, if the January futures price is $3.00/MMBtu and February is $3.25/MMBtu, the 2-month strip average would be $3.125/MMBtu. Suppliers use these averages to build customer contract offers.
They often package pricing into 12, 24, or 36-month strips depending on their procurement plan.
Understanding calendar strips is very important for energy brokers. It helps them see how market expectations affect the rates that customers pay for their energy supply contracts.
How Brokers Can Use Calendar Strip Pricing in Client Conversations
Calendar strip pricing is a useful tool for energy brokers. It helps guide clients on when to sign contracts and how to make smart decisions. By watching how strip prices move, brokers can tell clients when it may be a good time to lock in rates. This is especially true if the average price across months is lower than usual or below recent trends.
For example, if the 12-month strip shows a price drop due to mild weather or extra supply, it might be a good time to offer clients a 12-month fixed contract. Brokers can explain this using market data. Doing so helps clients see the value of timing their energy contracts.
Understanding forward visibility is also important. Forward visibility means that strip pricing shows expected future costs. When brokers explain this to clients, it gives them confidence in making long-term energy decisions. It also helps shift the conversation from reactive budgeting to proactive planning.
Peaks and Shoulders
Another important concept is peak months and shoulder months. Short-term energy prices are mostly driven by supply and demand. Cold winters and hot summers increase energy demand, so prices are usually higher in those seasons. Typically, energy futures trade higher in December through February and June through August. Experienced brokers know how to structure contracts to take advantage of lower-priced shoulder months.
For example, contracts ending in May or November often have lower rates because they include more shoulder months. This lowers the net cost for the supplier and allows brokers to offer cheaper energy to customers. By using this strategy, brokers can help clients save money while still managing seasonal price risks.
Pro Tips
Brokers can use some strategies to save clients money and reduce risk. One approach is to sell contracts that include more shoulder months than peak months. Shoulder months, usually in spring and fall, have lower demand and more stable prices.
Another tip is to lock in prices during peak months, which are often more volatile, and let shoulder months remain flexible. This strategy helps balance cost and risk. Understanding these techniques allows brokers to offer smarter, more cost-effective energy contracts to their clients.
Curious About Energy Futures
How Does Electricity Trading on the Futures Market Work?
Electricity is traded on the futures market using futures contracts. These contracts are legal agreements to buy or sell electricity at a set price for a future period. The period can range from a few weeks or months to several years. Each period is treated as a separate product.
Types of Futures
Futures are organized by the length of their delivery period:
- Week-Futures: These cover electricity deliveries for up to five weeks in advance.
- Weekend-Futures: These cover electricity for weekends and can be traded up to two weekends ahead. They help companies hedge against weekend demand spikes.
- Month-Futures: These allow trading electricity up to ten months in advance.
- Quarter-Futures: These cover electricity for up to eleven consecutive quarters.
- Year-Futures: These allow trading electricity up to six years in advance.
Usually, electricity producers sell these contracts, while suppliers buy them and deliver electricity to end customers. Large industrial companies with high electricity use also buy directly from producers. This helps them lock in prices and secure electricity over the long term.
Baseload and Peakload Futures
The futures market also separates contracts based on demand patterns: baseload and peakload.
- Baseload futures provide a constant supply of electricity, 24 hours a day, seven days a week. They cover the basic demand for electricity and are ideal for energy suppliers to guarantee a steady, uninterrupted supply.
- Peakload futures cover electricity during high-demand hours, from 8 AM to 8 PM, Monday through Friday. They ensure electricity is available when demand is highest and help suppliers manage the extra load beyond the base demand.
Both baseload and peakload futures reflect different patterns of electricity use. This distinction is key in structuring futures contracts, so electricity can be bought and sold either as base or peak.
Understanding Seasonal Price Risk
Seasonal price changes are very important in the energy futures market. Peak demand months, usually July and August in summer, and January and February in winter, often see large price increases. This happens because more people use heating and cooling systems, creating higher energy demand.
Extreme weather events can make these spikes even worse. For example, during Winter Storm Uri in 2021, natural gas and electricity prices surged in Texas and the ERCOT region. Frozen infrastructure and high demand caused prices to skyrocket. For energy brokers, understanding seasonal risks is essential. It helps them guide clients to make smarter decisions, avoid high-risk months, and build energy plans that are more resilient and cost-effective.
Strategic Contract Timing Using Shoulder Months
Shoulder months are usually in spring (April–May) and fall (October–November). During these months, energy demand is lower, and prices are more stable. The weather is milder, so heating and cooling needs are minimal. This makes the market less volatile.
For brokers, shoulder months create a strategic opportunity. They can structure energy supply contracts to start or end during these months. Doing this helps capture lower average rates and reduces overall energy costs.
For example, a 17-month contract from November to April may include only two peak months, January and February. The rest of the contract falls in shoulder months. This timing creates a more cost-effective plan for energy procurement and can save clients money while reducing risk.
Less Volatility Out of the Curve
To understand the difference between energy spot prices and energy future prices, it helps to know about the futures curve.
Each future month has its own price. When you put all these monthly prices together, you get a futures curve. The first month on this curve is called the front month. This is the nearest-term contract. When you hear natural gas or oil prices reported on news channels like CNBC, they are usually referring to the front-month contract. The front month is heavily influenced by short-term market conditions, like supply and demand.
As you move further out on the curve, contracts become less affected by short-term changes. Futures prices for months or years ahead are generally more stable and show less volatility than the front-month contract.
Energy brokers can use this to their advantage. By offering future-dated retail supply contracts, they can sometimes secure lower costs for their clients. High current market prices do not always mean that future prices will be high. Understanding the futures curve helps brokers find opportunities to save their customers money.
Pros and Cons of the Futures Market
The futures market gives electricity consumers and producers a way to fix prices for future deliveries. This provides planning security for both sides. Participants can also hedge against unwanted price changes, consumers protect against price increases, and producers protect against price drops. For companies with high energy costs, securing part of their future consumption is often essential. Suppliers may also need a minimum price level to cover costs.
However, there are some downsides to long-term electricity supply or offtake contracts. These agreements can prevent participants from benefiting if market prices move favorably in the future. Futures prices reflect the current market’s view of future trends, which can change daily. The actual spot market price at delivery can be very different from the current futures price.
For example, if spot market prices fall, participants who locked in higher prices may lose potential savings. Long-term contracts also reduce flexibility, making it harder to take advantage of short-term opportunities in fast-changing markets.
Deciding how much future consumption or production to commit to is essentially a strategic bet on the future. The price set in the futures market represents the market participants’ “best guess” of how supply and demand will change. The result of this bet is uncertain and cannot be predicted with certainty today.
What Is the Future Curve?
The futures curve is a line graph that shows the market price of energy contracts over a series of future delivery dates. These dates are usually organized by month or quarter. The curve gives a visual picture of how the market expects prices to change in the coming months or years.
On the futures curve, the front month is the nearest-term contract, such as the next calendar month. The outer curve shows contracts set 12 or more months into the future.
For energy brokers, the futures curve is a very useful tool. It shows patterns of price changes, market sentiment, and expectations for seasonal spikes. A steep upward curve can indicate rising prices due to expected constraints, while a flat or downward-sloping curve can suggest lower demand or ample supply. Brokers can use this information to help clients plan contracts and understand how future costs might change.
Can Customers Get Out of a Future-Dated Energy Contract?
Usually, customers cannot leave a future-dated energy contract early. The only reason a customer might want to go is if market prices drop below the contract price. In that case, they might save money by switching energy brokers.
If prices are higher, the customer benefits by staying in the contract at the lower rate. If a customer tries to exit a contract early or before it starts, retail suppliers usually charge an early termination fee. This fee can be as high as or higher than the cost for the supplier to sell the contract in the open market. If market prices are lower than the contract value, the supplier loses money when selling the energy back. That loss is then passed on to the customer through the early termination fee.
Learn More About Using Energy Futures
Suppose you want to use energy futures data to become a better energy broker. In that case, Great Energy 1 can help with expertise in energy futures and understand the different types of contracts traded in the market. We use this information every day to make smarter recommendations for our customers. Contact us today to learn how energy futures can help you manage and control energy costs more effectively.