Learn How to Trade Energy Commodities

Energy Trading

Why Are Energy Commodities Important?

Perhaps more than any category of commodities, energy has the biggest impact on our daily lives.

Energy prices affect the cost of virtually everything we consume including our groceries, the clothes we wear, the electronic devices we use and the gasoline we put in our cars. They determine the costs of heating and cooling our homes, businesses, factories, hospitals and schools. In fact, a world without energy would be a world without the vital things we need to survive!

The unit we typically use to define quantities of energy is the British thermal unit (Btu), which is a measurement of the heat content of fuels. According to the US Energy Information Agency (EIA), annual worldwide energy consumption exceeds 575 quadrillion Btu and is expected to grow to 736 quadrillion Btu by 2040, a 28% increase.

To put the enormity of these numbers into context, we can compare them to fossil fuel consumption in the world’s largest economy. The United States annually consumes:

  • 7.2 billion barrels of petroleum (35.9 quadrillion Btu),
  • 27.5 trillion cubic feet of natural gas (28.4 quadrillion Btu)
  • 729.5 million short tons of coal (14.2 quadrillion Btu)

Yet, US consumption of these fossil fuels amounts to only 13.6% of total global energy consumption.

In other words, the world consumes a staggeringly large amount of energy.

What Are the Different Types of Energy?

The energy we use can be divided into two groups:

Renewable – energy that can easily be replenished

Non-renewable – energy that can’t be replenished

Renewable Energy

Renewable Energy

Solar Park and Wind Farm – Image via Pixabay

Renewable energy accounts for about 21% of global electricity generation and about 12.5% of overall energy consumption. There are five main renewable energy sources:

  1. Solar – energy obtained from the sun
  2. Geothermal – energy harnessed from heat within the earth
  3. Wind – energy harnessed from the natural movement of air
  4. Biomass – energy obtained from living matter, usually from plants
  5. Hydropower – energy obtained from flowing water

In the United States, biomass accounts for about half of all renewable energy and 5% of total US energy consumption. The main biomass fuel is ethanol, which is a clear, colorless alcohol produced mostly from grains or sugar.

Non-Renewable Energy

Almost 90% of the energy consumed worldwide derives from five non-renewable sources:

  1. Petroleum Products – crude oil and various refined crude oil products including gasoline, heating oil, diesel fuel, jet fuel, lubricating oils and asphalt.
  2. Hydrocarbon gas liquids –gas liquids derived from natural gas and crude oil and include alkanes (e.g., propane and butane) and alkenes (e.g., ethylene and propylene).
  3. Natural gas – an energy consisting mainly of methane that is found deep beneath the earth’s surface.
  4. Coal – a sedimentary rock that can be burned for fuel.
  5. Nuclear energy – An energy source derived from splitting the atoms of uranium and producing a chain reaction of energy.

What Are the Main Energy Commodities?

With the exception of ethanol and some electricity generation, the most developed commodity trading markets are in non-renewable energy resources. In addition to regulated and (mostly) liquid futures markets, traders can invest in these commodities indirectly through products such as shares, exchange-traded funds (ETFs) and contracts for difference (CFDs).

CommodityDescriptionPrice FluctuationsFutures Exchange
Crude OilCrude oil has different variations based on geography and physical characteristics: West Texas Intermediate (WTI), also known as light sweet crude, and Brent Crude are two of the most frequently traded varieties.$0.01 per barrelNYMEX and ICE
GasolineCommodity markets trade a product known as Reformulated Blendstock for Oxygenate Blending (RBOB) gasoline. In the United States, about 47% of each barrel of crude oil goes to produce gasoline for cars and light-duty vehicles.$0.0001 per gallonNYMEX
Heating OilThis fuel is refined from crude oil and used to heat homes and businesses. In the United States, about 28% of each barrel of crude oil goes to produce distillates such as diesel fuel and heating oil.$0.0001 per gallonNYMEX
CoalCoal is a fossil fuel used mainly in power generation and steel production.$0.01 per tonICE Futures Europe
Natural GasNatural gas is a fossil fuel used in electric power generation and in a variety of residential, commercial and industrial applications such as heating and refrigeration.$0.001 per million BtuNYMEX
ElectricityElectricity powers virtually every segment of the world economy.$0.05 per megawatt hours (MWh)NYMEX
EthanolEthanol is used as a blending fuel with gasoline.$0.001 per gallonNYMEX
UraniumUranium is a radioactive metal used to produce nuclear energy.$0.05 per poundNYMEX

What are the Main Global Energy Trends?

Several long-term trends could create investment opportunities in energy over the next two decades:

  1. Emerging Market Growth
  2. Energy Efficiency Revolution
  3. Population Growth
  4. Electricity Penetration
  5. Industrialization in Developing Economies

Emerging Market Growth

One of the most important trends in energy markets is the disparity in expected energy demand between developed and developing nations.

emerging markets map

Emerging Markets Will Push Up Global Energy Usage – Image via Wikipedia

Global energy usage is expected to climb by almost 30% over the next two decades. However, growth in developed nations is forecast to remain flat. In other words, emerging market nations will account for the entire increase.

This forecast could have important ramifications for commodity markets. Traders should pay close attention to economic growth in emerging market economies for clues about energy demand.

Similarly, traders should pay close attention to new sources of energy supplies in emerging market countries. China and India, in particular, will have to make important decisions about issues such as ethanol production, nuclear energy programs and coal-fired power plants. These decisions could have a significant impact on individual commodity prices.

Energy Efficiency Revolution

The anticipated flat growth for energy in developed countries is not due to poor economic conditions. Rather, developed economies in North America and Europe will benefit from greater energy efficiency in the coming decades.

More efficient natural gas-fired power plants, smart grid technology and fuel-efficient cars are some of the developments that could produce a new energy efficiency revolution.

Lake Side Power Plant

Lake Side Power Plant – A Natural Gas Power Plant – Image via Wikipedia

One of the interesting unknown is how far these technologies can advance and how they might change the consumption shares of renewable versus non-renewable energy.

Investors can capitalize on these trends by investing in energy efficiency technologies.

Population Growth

By 2040, the world’s population is expected to exceed 9 billion. Demographers forecast that three-quarters of the world will reside in Asia or Africa at this time.

Word Population Growth

Word Population Growth – Image via Flickr

The growing world population will create new competition for energy resources. It will also likely spur new innovation in energy as fast-growing countries struggle to deal with rising demand and constrained energy resources.

China and India, in particular, will face the biggest challenges in managing population growth. As the people in these countries move from rural areas into cities, demand for energy will certainly rise. This could have an enormous impact on energy prices.

Electricity Penetration

Nearly 1.3 billion people in the world have no access to electricity, including about one-quarter of the population of India.

Over the next two decades, India and other emerging countries will invest in power grid infrastructure as their economies mature. These new power generators will require some sort of fuel– crude oil, natural gas, coal, nuclear or renewables – to operate.

As access to electricity expands to more economies across the globe, energy needs are bound to increase.

Industrialization in Developing Economies

Industrial demand for energy could top 70% by 2040. However, most of this demand will occur in developing economies.

According to ExxonMobil, industrial demand for energy in India will triple by 2040. India and other developing nations in Asia, the Middle East and Africa will require factories to supply metals, machines and manufactured goods.

This new source of industrial energy demand could offset waning demand from industry in developed countries.

Top Energy Producers

Top Energy Producing Countries

CommodityFlagTop Producing CountryAmount Produced
Crude OilRussia10,500,000 barrels per day
Natural GasFlag of USAUnited States of America766 billion cubic meters per year
CoalFlag of ChinaChina3,874 million tonnes per year
ElectricityFlag of ChinaChina6,142 billion kWh per year
EthanolFlag of USAUnited States of America15,329 millions of gallons per year
Heating OilFlag of USAUnited States of America18,119 thousand barrels per day
GasolineFlag of USAUnited States of America8,900 thousand barrels per day

Traders can follow the broad energy markets by monitoring the performance of some of the main indices that track the sector.

Energy indices are a good barometer for the health of the sector since they measure the performance of the shares of companies engaged in the production and sale of energy.

Energy companies typically have large initial capital costs to develop and explore for resources. Later in their development, they have mostly fixed costs such as salaries, rent and debt servicing.

However, energy companies always have variable revenues since revenues depend on the price of the commodity they are selling. In theory, then, investing in energy companies is a way to make a leveraged bet on the price of energy commodities. As the commodity’s price rises, more revenues should flow to the bottom line in the form of profits.

However, many factors other than commodity prices can affect the performance of energy company share prices:

Production costs: A rise or fall in the cost of wages or equipment, for example, affects profits.

Competition: The strength of competitors can affect the profitability of energy companies.

Interest rates: Changes in interest rates can affect the cost of debt servicing. This factor is especially important to utility companies with huge infrastructure financing costs.

Local Economies: The relative strength of the economy where a company sells its products can impact its profits.

Multiple Contraction or Expansion: The market assigns price/earnings multiples to companies based on perceptions of future prospects. Changes to these multiples can cause fluctuations in share prices.

5 Leading Energy Indices

IndexLast SaleDescription
S&P 500 Energy Index
Index that comprises those companies included in the S&P 500 that are classified as members of the energy sector.
Dow Jones U.S. Select Oil Equipment & Services Index
Index designed to measure the performance of U.S. companies in the oil equipment & services sector.
Dow Jones US Utilities Index
Index designed to measure the stock performance of U.S. companies in the utilities industry.
Dow Jones US Coal Index
Index that tracks stocks classified in the coal sector on major U.S. stock exchanges.
Nasdaq Clean Edge Green Energy Index
A market capitalization-weighted index designed to track the performance of companies that primarily manufacture, develop, distribute and/or install clean-energy technologies.

What Are The Top Energy Investment Resources?

Investors can find additional information on investing in energy from the following sources:

US Energy Information Administration (EIA): This US agency provides comprehensive statistical information on worldwide energy reserves, production, consumption and pricing data. EIA also includes forecasts and analysis of future energy trends.

International Energy Agency (IEA): This autonomous intergovernmental body strives to create cleaner forms of energy for its 29 nation members. Its website contains comprehensive reports, statistics and analyses of energy commodities and issues that impact energy markets. IEA publishes 90 books a year, including 70 free publications.

CME Group: This American financial company operates futures and options exchanges including the main energy futures exchange, the New York Mercantile Exchange (NYMEX). The CME publishes daily volume and open interest reports for energy commodities, educational courses on energy commodities trading, trading tools, brokerage resources and much more.

US Department of Energy: This agency publishes a treasure trove of information on global energy production and consumption across both renewable and non-renewable sources. Some of the most interesting features of its website include interactive maps showing the location of energy-related assets including crops used in biofuel production, power plants, pipelines and alternative fuel stations.

European Environmental Agency (EEA): This European Union agency provides independent data on the environment. Its goal is to help nations develop, adopt and implement beneficial energy policies. The EEA website has data, infographics and interactive charts and maps on topics including CO2 emissions, renewable energy, urban waste water treatment and other topics germane to the energy industry.

World Energy Council (WEC): This global energy body consists of leaders and energy practitioners interested in developing and promoting affordable and environmentally-friendly energy alternatives for the world. The agency produces publications and analyses on a diverse array of energy topics by leading experts in the field. WEC also publishes data for analyzing energy efficiency.

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Lawrence Pines is a Princeton University graduate with more than 25 years of experience as an equity and foreign exchange options trader for multinational banks and proprietary trading groups. Mr. Pines has traded on the NYSE, CBOE and Pacific Stock Exchange. In 2011, Mr. Pines started his own consulting firm through which he advises law firms and investment professionals on issues related to trading, and derivatives. Lawrence has served as an expert witness in a number of high profile trials in US Federal and international courts.
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