Energy trading involves products like crude oil, electricity, natural gas, and wind power. Since these commodities often fluctuate abruptly they can be attractive to speculators. In today’s world, our lives are completely dependent on an uninterrupted supply of energy for both living and working. It provides us with heat and electricity, fuels transportation, and powers industry. It propels innovation and allows humankind to progress as a society. The incessantly growing demand for energy, however, means global energy supplies have become a scarce commodity. Coupled with the fact that there are very few countries who can cover their energy needs from their own sources, energy trading has escalated significantly in importance globally.
Types of Physical Energy Trading
Similar to other commodities, virtually anything can be traded where a sufficient supply and demand exists. The most-traded energy commodities are crude oil and its derivatives, gas, coal, power, and petrochemicals.
Crude oil, gas, and coal are all fossil fuels that can be extracted from the earth. They are formed from the remains of dead organisms, both plant and animal, which have been subjected to heat and pressure over millions of years.
Crude oil: can be refined into different distillate groups which ultimately all serve different purposes: light distillates (LPG, gasoline, naphtha); heavy distillates (kerosene, jet fuel, diesel, gasoil); heavy distillates (heavy fuel oil/bunker fuel); residuum (wax, bitumen, lubricating oils). Oil traders tend to specialize in a specific group of oil products however some do trade ‘across the barrel’ meaning they have a multi-product oil focus. Countries in the Middle East and Russia are key players in oil trading, producing the largest share of world production.
Natural gas: is extracted from the deposit, purified, and piped to customers. When it is not possible to transport through pipelines, it can be converted into a liquid state (LNG), shipped, and then returned to its gaseous state on reaching the final destination. In Europe gas traders may operate within or across the NBP (National Balancing Point, UK); the TTF (Title Transfer Facility, Netherlands); the CEGH (Central European Gas Hub, Austria); the Zeebrugge Hub (Belgium); NCG (Net Connect Germany); PEG (Point d’Échange de Gaz Nord/Sud, France) or CEE (Central and Eastern European) hubs. In the United States, the main gas trading hub is Henry Hub, Louisiana.
Coal: is the most abundant and affordable energy fuel. Thermal coal, also known as steam coal, is the type of coal used to run turbines and generate electricity. It is actively mined in approximately 50 countries with China, the USA, and India producing the most. The global coal trading market is effectively divided into two regional markets, the Atlantic and Pacific regional markets due to high transportation costs.
Power or electricity: is the form of energy most people interact with the most with it playing an essential role in our daily lives. It stands apart from the other energy commodities in that it needs to be produced as it is consumed, meaning there are people constantly working to balance supply and demand. Power trading happens on a ‘day ahead’ or intraday/real-time basis to make sure demand is met in accordance with predicted or real-time data. Power traders play an instrumental role in making sure utility companies can secure a dependable supply of energy at a stable price.
Derived from petroleum or natural gas, petrochemicals play an essential role in the chemical industry. They are present in a plethora of ways in our daily lives, from household goods and electronics to medicines and automotive parts. While the final consumer never sees them, they ultimately become a part of many products we interact with on a daily basis. Petrochemical traders tend to trade petrochemicals in addition to other oil derivatives and products. Petrochemical production is affected by feedstock markets so much petrochemical trading occurs in financial markets to hedge exposure against feedstock prices.
Energy Derivatives Trading
Energy can be traded on the financial market in the form of energy derivatives. Energy derivatives are contracts based on an underlying physical asset such as crude oil, power, natural gas etc. The contracts can be in the form of futures, options, and over-the-counter (OTC) derivatives such as forwards, swaps, options, and swaptions. They can be traded on exchanges like the New York Mercantile Exchange (NYMEX), the Intercontinental Exchange (ICE) and the Tokyo Commodity Exchange (TOCOM).