Of all asset classes, commodities usually see the largest and most dramatic price movements, and of all commodities, it is typically the energy commodities which are the most exciting and which offer the best opportunities for traders to profit.
In this article, I will explain the various types of energy commodities, how to trade them, and the potential impact of growing markets upon demand for energies. Read on to learn more about how to trade this asset class sub-group profitably.
What Are Energy Commodities?
Before trading any asset, energy commodities included, traders must understand the sector and its components. Education and research should always precede actual trading.
Here is a list of the primary energy commodities:
- Crude Oil – Differences in crude oil, sometimes referred to as black gold, result from its composition based on geographic location. Brent Crude is the international benchmark, traded in London on the Intercontinental Exchange (ICE). West Texas Intermediate (WTI), the US benchmark, is traded on the New York Mercantile Exchange (NYMEX).
- Gasoline – Reformulated Blendstock for Oxygenate Blending (RBOB), refined from crude oil, fuels cars and other light-duty vehicles. It accounts for the bulk of oil refinement globally, primarily traded on the NYMEX.
- Heating Oil – It represents the second-most refined crude oil product, responsible for the heating of homes and businesses, and is traded on the NYMEX.
- Natural Gas – Natural gas ranks among the most important of all energy commodities, as a notably cleaner hydrocarbon than crude oil, and is likely to fulfill a more critical role in the future. The natural gas market continues to expand, with usage in power generation, transportation, fertilizers, hydrogen, animal feed, and various manufacturing processes. Most natural gas contracts change hands at the ICE and NYMEX.
- Coal – The dirtiest of all hydrocarbons, some developing countries heavily rely on coal for power generation. Its secondary use is in steel production, and the ICE remains the primary coal trading exchange.
- Electricity – Part of the global economic backbone and traded across commodity exchanges. The means of electricity production impact prices, and the market is highly decentralized, localized, and volatile.
- Ethanol – The fermentation of sugars by yeasts or petrochemical processes produces ethanol. Usages include gasoline blending, medical and chemical applications, or personal consumption. Ethanol is also present in rocket fuel and fuel cells within commercial applications.
- Uranium – This radioactive metal is primarily used in nuclear power plants for clean and low-cost electricity generation. Some militaries use depleted uranium in first strike and deterrent weapons systems.
Why are energy commodities so vital to the global economy?
Life is impossible without energy, as is the production of most goods and services, so it is an essential ingredient in practically all economic activity.
- Energy heats and cools our homes, schools, and hospitals, and powers our factories.
- Energy impacts food prices, as food supply chains require inputs of energy, from planting, growing, and harvesting to storing and transporting.
- All transportation requires energy.
- Energy powers communication and the internet, enabling tens of millions of entrepreneurs and companies to conduct business and billions of consumers to transact.
The two types of energy commodities
The energy commodity sector can be divided into two sub-categories, non-renewable and renewable (sometimes referred to as alternative or green energy).
Non-renewable energy sources:
- Petroleum products
- Natural gas
- Hydrocarbon gas liquids
- Nuclear energy
- Coal
Coal will become the first hydrocarbon product to be phased out of the global energy chain, as it remains the dirtiest method of generating electricity, with the highest pollution.
Crude oil as an energy source will eventually follow coal, but natural gas and nuclear energy are likely to form the backbone of the ongoing energy revolution.
Renewable energy sources:
- Solar
- Wind
- Hydropower
- Tidal
- Biomass
- Geothermal
Solar and wind are leading the alternative (or “green energy” revolution), but challenges remain, mainly storage and reliability issues. New technology continues to address these challenges, and within the next two decades, renewable energy could account for most global energy production.
The Future of Energy Commodities
The types and future of non-renewable energies
Petroleum products, natural gas, hydrocarbon gas liquids, nuclear energy, and coal account for roughly 90% of non-renewable energy production and more than 75% of electricity generation globally. The existing infrastructure and availability of raw materials will ensure their continued dominance, but their climate impact will drive their gradual replacement with alternative sources of energy. With rapidly progressing advancements in technology across the alternative energy pipeline, this sector should witness accelerated growth with accompanying outstanding investment and trading opportunities.
Which primary global energy trends should traders monitor?
- Global population growth continues to fuel the overall demand for energy commodities.
- Emerging market growth will drive demand for traditional non-renewable energies.
- Developed market growth continues to push for more renewable energy, driving replacement of dated and environmentally unfriendly sources.
- Electricity penetration connects more consumers to the grid, with over 20% of the global population still not electrified.
- Greater energy efficiencies will further advance renewable energy use in developed economies, countering emerging markets and their push for non-renewables over the next two decades before they begin upgrading to alternative sources.
The next two to three decades will see a surge in energy requirements and consumption, where developed markets focus on alternative energy and efficiency. Emerging markets will power demand for non-renewables before closing the gap with developed ones, creating exciting opportunities for traders globally.
What is the impact of expanding markets on energy commodities?
China, India, and the African continent remain three areas fundamental-based energy commodity traders should closely monitor. Rising GDP powers an increase in industrial energy usage, and increased connectivity to the electricity grid adds demand from consumers. Decisions by each government on how to proceed in meeting these increasing demands will have a material impact on the energy sources and technologies used.
How to Trade Energy Commodities?
Trend or momentum-based technical analysis can be a powerful way to trade energy commodities. Over recent decades, buying energy commodities at 6-month highs has produced excellent positive results, so going long on long-term bullish breakouts and using a volatility-based trailing stop has historically been profitable.
Energy commodity trade ideas:
- Traders can focus on individual energy commodities, researching demand and supply based on geographic location.
- Geopolitical news can temporarily disrupt price action for short-term opportunities.
- GDP growth fuels longer-term price changes.
- Electricity penetration presents opportunities to trade electricity contracts and investment in grid operators.
Accessing energy commodities:
A wide variety of instruments can be used to access exposure to energy commodities: futures, options, ETFs and ETNs, CFDs, and shares in energy companies.
- Many international traders can use CFD contracts, granting exposure to price action without owning the underlying asset, while futures and options contracts are two alternatives.
- Most CFD brokers offer at least crude oil and natural gas, allowing traders direct exposure to the two major non-renewable energy commodities.
- ETFs offer traders access to any energy commodity, sector, or market participant, so is an ideal tool for diversified exposure.
- Indirect exposure to energy commodities might be achieved through stocks in individual energy companies.
Are energy commodity price indices useful to traders?
An energy commodity price index is ideal for a balanced and diversified direct investment, and beginner traders should consider trading an energy commodity price index before venturing into individual energies. Such indices, for example the MSCI World Energy Index, track a basket of energy commodities and can allow traders to capture longer-term trends in energy at lower overall risk.
Final Thoughts
Energy commodities offer traders a multi-approach to various global themes, as they are part of the backbone of our economy. Traders must understand that the exciting opportunities, driven by themes like energy revolution and electricity penetration, remain high-risk. The primary reason for this is the series of unpredictable events that can impact price action. Weather patterns, disrupted by global weather changes, and disasters, can disrupt the market by destroying supplies.
Energy commodities, notably crude oil, have produced excellent results for trend traders in recent decades. However, energy commodities can be very volatile, so it is important that traders carefully size their trade positions, reducing size when volatility is abnormally high.
Yet this volatility can also be a truly outstanding generator of trading profits.
Newer, cleaner energies may show tremendous market growth over coming years, so potentially offer great opportunities as investments. It may be better to gain exposure to that through buying shares in the companies driving the technologies which will be used to allow more widespread use of these energies, rather than purchasing instruments representing units of the energies themselves.
FAQs
How are energy commodities traded?
The primary instruments for trading energy commodities are futures, options, CFDs, ETFs, and stocks.
How do I invest in energy commodities?
Traders need a funded brokerage account with access to energy commodity trading instruments and/or shares in energy companies.
Is electricity a commodity?
Electricity shares some of the features of a commodity but is not truly a commodity. Electricity is a unique product with wild price fluctuations based on numerous factors, tracked by power exchanges.
What are today's important commodities?
Commodities traders today should focus on crude oil and its byproducts, natural gas, ethanol, uranium, cobalt, lithium, and nickel.
What are green energy commodities?
Green energy commodities are renewable energy sources like solar, wind, hydropower, tidal, biomass, and geothermal energy. They are environmentally friendlier and are slowly replacing non-renewable energy sources, especially in more developed countries.