Last Updated on 11 September, 2023 by Samuelsson
The financial market has become so diverse with so many securities available to traders. One of such is energy trading. If you’re unfamiliar with what energy trading is or you are just looking to broaden your knowledge to maximize profits potential, then this is the right article for you. Today we will be discussing what energy trading is and the different types of tradable energy commodities.
Energy trading refers to the buying and selling of different energy commodities such as natural gas, oil, gasoline, heating oil, and even electricity. These energy commodities are traded in the futures market but can also be traded on OTC markets as forward contracts. Energy ETFs and stocks of energy companies are also traded on the equity market. There are also the stocks and ETFs of non-renewable energy sources.
To help you understand this topic, we will discuss it under the following headings:
- What is energy trading
- Different types of energy commodities
- Which countries produce the most energy
- Understanding the role of energy commodities
- How to trade the energy market
- Understanding energy market trends
What is energy trading?
Energy trading involves trading different energy commodities such as gasoline, heating oil, electricity, and natural gas. While these energy commodities are traded in the futures market, they can also be traded on OTC markets as forward and swap contracts. Energy commodities are highly volatile and tend to experience wide swings in price which provide opportunities for traders to make more money from them.
There are also other energy instruments that can offer you exposure to the energy market. These include energy ETFs and stocks of energy companies, which are traded on the equity market. You can also trade energy CFDs through online CFD brokers; however, most energy CFDs track the corresponding energy futures.
Energy trading also includes stocks of companies engaged in using renewable energy sources, such as solar, hydropower, geothermal, wind, and biomass, to provide electricity and other energy solutions.
Different types of energy commodities
The most popular energy commodities in the market include crude oil and its derivatives, power, coal, and petrochemicals. Crude oil, coal, and gas (fossil fuels) can be extracted from the earth — they are formed from the build-up of dead organisms including plants and animals subjected to pressure and heat for over a million years.
- Crude oil and its products: Oil products exist in different distillates for different purposes such as light distillates (gasoline, LPG, naphtha); heavy distillate (jet fuel, kerosene, gas oil, diesel); heavy distillate (bunker fuel/heavy oil); residuum (bitumen, wax, lubricating oils). While crude oil traders mostly focus on a specific group of oil products (gasoline, diesel, or kerosene), some traders trade “across the barrel” —e. they trade more than one oil product.
- Coal: There’s more coal in the world than any other energy commodity and it is very affordable compared with other energy sources. Thermal coal which is also called steam coal is a type used to power turbines and generate electricity. Coal is mined in about 50 countries with the largest producers being China, the US, and India respectively. The coal market is divided into two regional markets globally: the Pacific and Atlantic regional due to the high transportation costs.
- Natural gas: This is usually piped to customers after its extraction. Sometimes, it is converted into a liquid state (LNG) (when it becomes impossible to transport it through pipe channels) and shipped to its destination in this state before being converted to its gaseous state.
- Electricity: This is the form of energy most people interact and are familiar with on a day-to-day basis, which plays a vital role in our everyday lives. It stands out from all the other forms of energy commodities in that it is consumed as it is produced. Electricity trading takes place a day ahead or on an intraday/real-time basis to ensure that the demand is matched with the real-time or forecasted data. Electricity traders play an important role in the market helping utility companies maintain a constant and dependable supply of electricity at a stable price.
Which countries produce the most energy?
Below are the top energy-producing countries in the world:
|Commodity||Top producer||Amount produced|
|Crude oil||Russia||10,500,000 barrels/day|
|Natural gas||USA||766 billion cubic meters/year|
|Coal||China||3,874 million tonnes/year|
|Ethanol||USA||15,329 million gallons/year|
|Electricity||China||6.142 billion kWh/year|
|Heating oil||USA||18,119 thousand barrels/day|
|Gasoline||USA||8,900 thousand barrels/day|
Understanding the role of energy commodities
Out of the numerous commodities available, energy has the most significant impact on our everyday life.
The price of energy directly impacts the price of almost everything we consume including the clothes we wear, groceries, devices we use, electronics, and even the gasoline we put in our cars. The cost of heating and cooling our homes, factories, hospitals, businesses, and schools is determined by our energy consumption.
The British Thermal Unit (BTU) is the unit we use to define the quantity of energy we consume – a measure of the heat content of fuels.
According to a report by the US Energy Information Agency (EIA), the annual global energy consumption has surpassed 125 quadrillions Btu and it is expected that this number will grow to about 138 quadrillions Btu by the year 2050.
The energy we consume can be divided into two categories: renewable and non-renewable.
Renewable energy makes up about 21% of the world’s power generation and approximately 12.5 of total energy consumption. The five main sources of renewable energy include solar, geothermal, biomass, wind, and hydropower energy.
In the United States alone, biomass makes up about 50% of all renewable energy and 5% of the country’s total energy consumption. The primary biomass fuel is ethanol – a clear, colorless alcohol that is produced mostly from sugar or grains.
However, approximately 90% of the total world’s energy consumption comes from non-renewable energy sources such as petroleum products (crude oil, gasoline, diesel, jet fuel, lubricating oils, heating oil, and asphalt), hydrocarbon gas liquids (propane, butane, ethylene, and propylene), natural gas (methane), coal, and nuclear energy sources (Uranium).
How to trade the energy market
You can trade the energy market via any of the following instruments:
- Energy commodity futures: Some energy commodities follow seasonal patterns which you can use as a confirmation to either buy or sell depending on the bias been given. For example, the WTI crude oil appreciates during the summer/spring season and depreciates in the fall/winter. This is because during the summer there is more demand for crude oil and less demand in the fall. Peak demand for refined fuels commence from Memorial Day and ends on Labor Day. This typically produces a rally in the WTI crude oil futures as refiner needs increase, followed by a decline as we approach winter. Also, during the summer driving season, there is high interstate traveling in the United States boosting the demand for gasoline – a byproduct of crude oil. Natural gas on the other hand also shows some seasonal patterns. For example, prices peak in anticipation of winter because of the need for heating.
- Energy stocks: Some energy stocks you can trade include APA Corp. (APA), Antero Midstream Corp. (AM), Marathon Petroleum Corp. (MPC), Valero Energy Corp. (VLO), ONEOK Inc. (OKE), ConocoPhillips (COP), TotalEnergies (TOT), and First Solar (FSLR).
- Energy ETFs: Some energy ETFs you can trade include Energy Select Sector SPDR ETF (XLE), iShares Global Energy ETF (IXC), First Trust Natural Gas ETF (FCG), First Trust NASDAQ Clean Edge Green Energy Index Fund (QCLN), Invesco Solar ETF (TAN), Vanguard Energy ETF (VDE), and SPDR S&P Oil & Gas Exploration & Production ETF (XOP).
- Energy CFDs: Energy CFDs may be the easiest to trade because there are many online CFD traders to trade with, and they usually require little margin, unlike futures that may require up to $5,000. However, CFD trading is often associated with a lack of transparency and conflict of interest. It may be better to trade energy commodity futures, energy stocks, or energy ETFs.
You can also trade over-the-counter energy derivatives contracts, such as forwards, swaps, options forwards, and swap options contracts.
Understanding energy market trends
The following are long-term market trends that could produce better trading opportunities over the next two decades.
- Emerging Market Growth
- Population Growth
- Energy Efficiency Revolution
- Industrialization in Developing Economies
- Electricity Penetration
The most significant trend in the energy markets is the gap between the expected energy demand between developing and developed countries.
World energy consumption is predicted to increase by 30% over the next two decades. But the demand in developed countries is expected to remain flat. This means that most of the growth will be from emerging market countries. These predictions could have a significant implication for the commodity market for a trader to take advantage of.
Let’s take a look at those factors that can influence energy market trends.
The impact of emerging market growth on the demand for energy
Traders must be alert to the economic growth in emerging market economies for trends in energy demand. Additionally, traders should also take note of alternative sources of energy production in these emerging markets.
However, China and India will have to make key decisions about the issues of nuclear energy programs, ethanol production, and coal-fired power plants as these decisions could impact the prices of these commodities greatly.
The implications of population growth to energy usage
The world’s population is predicted to exceed 9 billion by the year 2040, with three-quarters of that living in Africa or Asia according to demographers.
This continuous growth in the world population will create new competition for energy supply and also give birth to innovations in the energy industries as fast-growing economies will struggle to keep up with the increasing demand and limited supply of energy. China and India will however have the biggest bottleneck in managing the population growth.
Well, this will be mostly due to the fact that people will move from rural communities into cities thereby creating a higher demand for energy which could have a significant impact on energy prices.
The effects of energy efficiency revolution
The predicted flat growth for energy in developed nations is not because their economic conditions are bad rather they will benefit from greater energy efficiency in the long run.
Smart grid technology, more efficient natural gas-fired power plants, and fuel-efficient cars are some of the positive innovations that could bring about a new revolution in energy efficiency. The most fascinating unknown fact is how far or to what length these innovations can advance or how they might be a game-changer in the consumption shares of renewable energy to non-renewable energy. Traders can take advantage of these trends by trading efficient energy technologies.
The effects of industrialization in developing economies
The industrial energy demand could reach up to 70% by the year 2040. But most of these demands may be happening in developing nations. According to a report by ExxonMobil, the industrial demand for energy in India will increase threefold by 2040.
India and other developing countries in Africa, Asia, and the Middle East will need factories to manufacture goods, supply metals, and machines.
This development will increase the demand for industrial energy which could offset the ebbing demand from industries in developed countries.
Increasing electricity penetration
About 1.3 billion of the world population have no access to power – this includes about one-third of Indian’s population.
In the coming decades, India and other emerging countries will have to trade power grid infrastructures as their economies begin to show positive growth.
These power generators will need some form of fuel like natural gas, crude oil, coal, and non-renewables to function. As the access to power expands to more countries across the world, energy demands are bound to increase.
There is a lot of opportunity in the energy market for traders and investors but proper knowledge is needed to navigate this volatile market. Note that before trading a particular energy commodity, you should have made diligent research on that market and what news impacts its price and the margin requirements. There are many ways to trade the energy market, so choose the one that suits you.