Energy Market Tutorial

1. Energy Market Tutorial Presented by Company Webb

2. Energy Discussion Topics • Basic Definitions • Exploration and Production • Energy Supply and Demand • Petroleum Refining • Energy Commodity Trading • Physical versus Financial Trading • New York Mercantile Exchange • Trading Terminology • Conclusion

3. Basic Definitions • Petroleum refers to crude oil or the refined products obtained from the processing of crude oil (gasoline, diesel fuel, heating oil, etc) • Natural gas is a nonrenewable source of energy used for heating and generating electricity

4. Basic Definitions • Crude oil is measured in barrels • 1 barrel = 42 gallons • Natural gas is measured in British Thermal Units (BTU) • 1 BTU = amount of heat energy required to raise 1 lb of water by 1 degree Fahrenheit • Gasoline is measured in gallons • 1 gallon of gasoline = 124,000 BTUs

5. Exploration and Production • Oil and natural gas were formed from the remains of animals and plants that lived millions of years ago in a marine (water) environment before the dinosaurs • Over the years, the remains were covered by layers of mud • Heat and pressure from these layers helped the remains turn into crude oil, natural gas, and coal

6. Energy Supply • The world’s top 5 crude oil producing countries are: • Saudi Arabia • Russia • United States • Iran • China • About 59.5% of petroleum used in the U.S. comes from other countries

7. Energy Supply • Most of the natural gas consumed in the United States is produced in the United States • There were 394 active underground storage fields in the Unites States in 2005 • The Federal offshore Gulf of Mexico and 5 states accounted for 77.1% of natural gas production in 2005

8. Energy Demand • In 2005, total US petroleum demand was 20.8 million barrels per day • In 2004, the 3 top petroleum consumers were: • United States • China • Japan • Approximately 22% of US energy consumption comes from natural gas

9. Petroleum Refining • A refinery takes crude oil and turns it into gasoline and hundreds of other useful products • Products from crude oil include gasoline, diesel fuel, heating oil, jet fuel, and asphalt

10. Petroleum Refining • Products made from a barrel of crude oil

11. Energy Commodity Trading • Commodities can be traded either physically or financially • Physical trading involves the “actual delivery” and receipt of the commodity • For example, Company A agrees to deliver 100 barrels of crude oil to Company B at a specific location and price today • Financial trading involves “contracts” for future delivery • For example, Company A agrees to deliver 100 barrels of crude oil to Company B at a specific location and price at some time in the future • Delivery and receipt only required if contract expires and holder hasn’t offset (e.g. sold/bought contract to/from another person)

12. Energy Commodity Trading • Physical vs. Financial • Under a physical transaction, delivery and receipt of the commodity is required for each party at a time shortly after the transaction date (e.g. for natural gas, delivery/receipt may be required the next day) • Under a financial transaction, each party is obligated to deliver and receive the commodity at some time in the future • Trader not obligated if the contract position is offset to another party before the contract expires • The contracts that are traded are financial derivatives that derive their value from the underlying commodity

13. Energy Commodity Trading • The New York Mercantile Exchange (NYMEX) is a regulated exchange that facilitates the trading of financial energy commodity contracts (i.e. futures contracts) • NYMEX provides liquidity, price transparency, and credit to the buyer and seller of the contract • NYMEX also acts as “clearinghouse” to each transaction • Buyer buys from NYMEX • Seller sells to NYMEX

14. Terminology • Energy trading is no different than stock or bond trading • A trader forms a market view and takes the corresponding position • If trader believes that prices will rise (bullish), the trader should buy low, then sell high • If trader believes that prices will fall (bearish), the trader should sell high, then buy low • A trader’s position is either long or short • If long, the trader has bought more contracts than he has sold • If short, the trader has sold more contracts than he has bought

15. Terminology

16. Terminology • The New York Mercantile Exchange requires the holder of a futures contract to post margin • Margin is similar to the collateral that your lender would require for a loan • Margin requirements change as the price and volatility of the commodity change • A rule of thumb is that margin requirements are about 10% of the contract value

17. Terminology • The terms of a futures contracts are standardized for each transaction • Volume • $/unit • Delivery/Receipt Location • Each commodity contract has its own specific terms:

18. Crude Oil Example • Trader buys contract when crude is $60/barrel • Since trader buys contract, he expects prices to rise (I.e. bullish) • NYMEX requires trader to post margin (if 10% of contract value, then $6,000) • Trader owns a contract worth $60,000 • Trader sells contract when crude is $80/barrel • NYMEX releases margin (assumed to be $6,000) • Trader sells a contract worth $80,000 • Trader profits by $20,000 because he bought a contract for $60,000 and sold for $80,000

19. Crude Oil Example • The trader only needed $6,000 to make $20,000 in this example • Trader could have lost $20,000 if prices fell to $40/barrel • Compare this example to stock investments • Trader buys 100 shares of ABC stock at $60/share (100 shares * $60/share = $6,000) • Trader sells 100 shares of ABC stock at $80/share • Trader profits by $2,000 (100 shares * $20/share)

20. Conclusion • The energy markets have attracted many investors over the last decade • Energy prices are extremely volatile • Volatility creates both risk and opportunity • Not suitable for everyone • Contact info@energymarketmaker.com for more information