Relative to equity markets or other well behaved markets, commodities markets are like the wild wild west. Suits, utilities, wholesalers, mom & pop consumers exchange pieces of paper that represent physical commodities like barrels of oil or bushels of corn. Consumers then take delivery of these pieces of paper and later use them in the real economy (gasp). Securitization and trading automation have made slow progress in dragging commodities markets kicking and screaming into the 21st century. Let’s look at some features of commodities markets that make them so different.

Let’s begin with Natural Gas Markets:

So you want to start a Natural Gas Market Making business? Who are your clients/who are you going to be trading with? There’s two main types of actors in nat gas markets: financial companies and corporates.

Financial companies such as hedge funds or asset managers will trade with you pretty idiosyncratically. Commodities hedge funds will be expressing a short term or medium term views. Incidentally, commodities hedge funds haven’t been doing so well these past few years, but we’ll talk about that later. Historically, asset managers liked to have a small commodities allocation as part of their portfolio, mainly for diversification reasons. Other asset managers might use commodities as a hedge against real economic inflation. Keep in mind that medium term historical commodities underperformance has caused many asset managers to scale down their commodities allocation.

In the corporate space, there are a whole bunch of people that you’ll be talking to. There are producers of nat gas that specialize in sending people out to punch holes in the ground. There are companies that specialize in refinement, transport, and storage of nat gas. There are consumers such as utilities that use the nat gas to make fire that heats water that turns turbines (real engineer right here). There are other consumers such as Con Ed that uses the gas to heat our homes. And then there are big commodities trading companies such as Glencore that manage the end to end process.