Energy Commodities Trading Explained

The energy market is undoubtedly one of the most crucial and vital markets out there as it serves various goals, including power and heat provision. 

Accordingly, it may interest many traders and investors seeking to diversify their portfolios and gain access to a dynamic market. 

In this article, we explore energy commodity trading, why it is important, and how to engage in it through Futures contracts:

TL;DR

• Energy trading involves the trading of energy commodities like crude oil, natural gas, gasoline, coal, and even renewable energy sources like wind power.

• Volatility in energy prices, driven by factors like geopolitical conflicts (e.g., the Russia-Ukraine war) and market forces, presents both risks and opportunities for investors and traders.

• Inflation, supply disruptions, and demand fluctuations influence energy market trends, leading to price swings in commodities like oil and natural gas.

• Oil and natural gas prices don’t always rise and fall together, but oil tends to have a stronger influence on natural gas prices.

• Higher oil prices contribute to inflation, affecting transportation, production, and consumer goods costs.

• Investors can trade energy commodities through Futures contracts.

What Is Energy Trading?

Energy trading or commodity trading refers to trading commodities and energy sources like crude oil, natural gas (NG), gasoline (RB), heating oil(HO), coal, electricity, and wind power, among others. There is quite a bit of volatility in energy commodities which makes it a big traction for traders who look for potential profits off of price swings. Needless to say, this sector is one of the most indispensable sectors as our industries and homes rely heavily on it. (Source: EIA)

Understanding Energy Market Trends: What Causes Energy Market Volatility?

The energy market usually gains attraction because energy commodities are volatile, which can attract risk-taking investors. This is because consumers are generally limited in their ability to substitute other fuels when the price of natural gas, for example, fluctuates, making prices of basic energy like natural gas and heating oil more volatile.

Energy commodities’ volatility was especially evident in the past couple of years, as the atrocious war between Russia and Ukraine definitely had its impact on the energy market. Due to concerns surrounding Russian crude being shut out of the market ever since the Russian invasion of Ukraine in February up until September of 2022, 130 million barrels of crude have been drained from Gulf Coast government caverns. Such apprehensions lifted the price of oil from time to time. However, on the other side of the equation, inflation, rising fears of a global recession, and interest rate hikes have led to oil prices dwindling that year. (Source: WallStreetJournal)

Do Oil and Natural Gas Prices Rise and Fall Together?

It might not come as a surprise to some that the energy sector and its various components can affect one another, so a question that might come to mind is whether oil and natural gas prices rise and fall in tandem. The answer to this question is not black or white. Based on historical data and price patterns, experts infer that no conclusive decision can be reached regarding the relationship between the two commodities. Nonetheless, it has been said that oil has a higher tendency to affect natural gas prices than the other way around. (Source: Investopedia)

How does the price of Oil affect the economy?

Oil is a multifaceted and vital commodity used for various purposes, from heating to producing electricity and moving vehicles. So it might not come as a surprise that black gold has macroeconomic effects. Accordingly, it is believed that higher oil prices have a general correlative effect on inflation in that they indirectly affect energy-reliant products and services like heating, production, and transportation. In other words, consumer prices can be influenced by Oil’s hiked prices since many services rely on it, which may cause an inflationary economy. On the flip side, higher oil prices can also deteriorate the supply and demand of other goods because expensive oil may lead to a more costly production process. At the same time, higher oil prices can also reduce the demand for other goods. Nonetheless, past results are no guarantee of future performance, and hence, this relationship is not a rule of thumb. (Source: Federal Reserve Bank of San Francisco)

How to trade energy commodities

Accessing the energy sphere can be done in a myriad of ways, such as trading energy ETFs or Futures contracts. Traditional commodity trading, for example,  was done through Futures contracts, which are derivative agreements that predetermine the price, quantity, and quality of the goods. When a Futures contract expires, preset prices and quantities must be paid. 

What Is the Carbon Trade?

It is no secret that energy commodities can also cause environmental pollution, especially when emitted from factories, and this is where Carbon Trading comes into play. Carbon trading refers to the process of granting (through buying or selling) certain companies the right to emit a certain amount of carbon dioxide. The process comes in an effort to minimize global warming and climate change brought about by the use of fossil fuels. According to this process, a permit holder must have enough permits to cover his emissions, and the governmental body that grants the same is limited to a fixed number of licenses over a certain period. 

Energy Technology Companies

Energy Technology companies may be a ray of hope in the midst of the incontrovertible deterioration of the global climate.

An interdisciplinary engineering science, energy technology aims to extract, convert, transport, store, and use energy in an efficient, safe, environmentally friendly, and economical manner without causing adverse effects on humans, nature, or the environment. Another term for this field is “Greentech,” and some prominent companies from this sector include Alphabet (GOOG), Apple (APPL), and Microsoft (MSFT), all of which have dipped their toes into the green energy field by adhering to Environmental, Social, and Governance (ESG) factors. 

Conclusion 

The energy market is a dynamic and essential sector for global economies. As a key component of modern life, energy commodities like oil, natural gas, and renewable energy sources experience significant volatility, especially in times of geopolitical instability or economic disruption. This volatility creates investment opportunities and risks for traders. While oil has a profound influence on natural gas prices, the relationship between these commodities is complex and varies over time. Beyond traditional energy trading, new markets such as carbon trading and sustainable energy technologies are gaining traction, offering additional avenues for investment. Understanding these trends is crucial for anyone looking to engage in energy trading or investment.

FAQs:

What is energy trading?

Energy trading involves buying and selling energy commodities like oil, gas, coal, and electricity, often through Futures contracts, ETFs, or CFDs. Traders profit from price fluctuations in these markets.

Why is the energy market so volatile?

The energy market is volatile due to factors such as geopolitical tensions, economic shifts, supply chain disruptions, and seasonal demand changes. Events like the Russia-Ukraine war can cause significant price swings.

How do oil prices affect the economy?

Higher oil prices can lead to inflation, as they increase transportation and production costs. This may result in higher consumer prices and a reduction in demand for other goods due to costlier production processes.

What is carbon trading?

Carbon trading is a system where companies are granted a set amount of carbon emissions they can produce. If they exceed this limit, they must purchase additional emissions permits. The goal is to reduce global emissions and combat climate change.