How to Invest in Energy: An Energy Trading Guide
Energy trading involves the buying and selling of various energy-related commodities such as oil and gas, to try and make a profit. Energy trading comes with many risks. Becoming an energy trader requires time, knowledge and a deep understanding of the market.
In this 'How to Invest in Energy' guide, we explain what you should know about trading the energy market. We explore the different types of energy trading markets, and how to start trading these markets yourself.
Table of Contents
What is Energy Trading
What is energy trading? Energy trading involves the buying and selling of energy markets. It is the process of investing in or speculating on the price direction of energy markets such as oil, gas and (renewable) electricity.
The most commonly traded energy markets include:
- WTI Crude Oil - WTI is short for West Texas Intermediate. It’s a well-known and very popular energy market to trade on. WTI crude oil is used as a benchmark for others, including the media. When the media quotes the price of oil, they usually refer to the WTI oil price
- Brent Crude Oil - Most people with an interest in WTI also know about Brent, and vice versa. Brent is another crude oil, closely related to WTI. The price of Brent is correlated with WTI and also functions in a similar way as a benchmark for traders.
- Natural Gas - Natural gas is a form of fuel that can be found deep beneath the earth’s surface. The price of natural gas is affected by circumstances including weather, storage, supply and demand. Other influences also include political risk, as regulations make it more difficult to extract from the reserves that are still left. They can heighten the operational costs, and therefore the price.
Difference between WTI and Brent Crude Oil
There are some key differences between WTI and Brent. The most important difference is the extraction location. WTI crude oil is being extracted from the United States, Texas, North Dakota and Louisiana in particular. Brent is extracted from oil fields located in the North Sea.
This means that there are slight differences between both products. Take for example oil density and ‘sweetness’. However, more important than those are factors such as transportation. Brent is much easier to transport because it’s extracted at sea.
And that’s important for pricing. Location and logistics can be a huge factor in the oil trading industry, just like global and local economic forces.
How does Energy Trading Work
Energy trading can be done via a broker and is traded via futures exchanges or over-the-counter (OTC). Being an energy trader is not limited to large funds and companies, as individuals can also participate as they wish.
Traders can also trade on energy stocks. These are companies that are focused on providing energy products to the world. There are also energy ETFs (exchange-traded funds) which allow investors to track a certain industry of the energy market. We discuss each type later in the article.
Energy futures contracts, energy stocks and energy ETFs can also be traded using CFDs (contracts for difference). This allows traders to trade long and short and potentially profit from rising and falling markets using leverage which magnifies wins and losses.
The goal of energy traders is to try and make a profit from the price swings that happen in the energy market. They do this by using a variety of tools to analyse the energy market. Information can be gained through technical analysis or fundamental analysis.
- Technical analysis is the process of analysing the price of a market using chart patterns and technical indicators.
- Fundamental analysis is the process of analysing macroeconomic data such as oil inventory reports and changes in the supply and demand of gas.
Examples of Trading Energy
Here are just two examples of how energy traders may operate.
1. Trade Energy Price Volatility
The price of energy trading commodities is determined by finding the balance between supply and demand. This balance is sought continuously as supply and demand change over time.
For example, during a harsh winter, the demand for natural gas goes up, since both people and companies need gas to heat their homes and buildings. As the demand goes up, but supply stays the same, the price of natural gas may also go up during such an event as companies are willing to pay more for what is available.
When logistical problems come into play as well, that might reduce the supply further and cause a further rise in prices. That could be the case when a natural gas pipeline is disrupted during or leading up to those months.
This type of analysis requires constant attention to world events and the possible impact they will have on the supply and demand of different energy markets.
2. Trade Long Term Energy Trends
Another way of energy trading is to use more of a global macro trading style. This is where investors would try to analyse long-term trends in an energy market and position themselves accordingly.
For example, due to climate change, there has been a lot of talk about renewable energy sources. Investors could position themselves accordingly in different renewable energy stocks or in the materials used to create wind turbines.
Identifying the themes of the future and investing in them, takes a lot of patience and research.
What are Energy Stocks
Energy stocks are stocks that represent companies involved in the production, distribution and sale of energy commodities. The stocks can be traded using a broker or online trading platform. Categories include renewable energy stocks, gas stocks, coal mining stocks and oil stocks, among others.
Examples of the biggest energy companies in the US and UK:
Oil Energy Stocks
Oil energy stocks are assets that revolve around companies that produce and sell products related to oil. Examples include crude oil, gasoline and diesel fuel. Well-known oil energy stocks include Chevron, ExxonMobil and Shell.
Gas Energy Stocks
Gas energy stocks are companies that produce and sell natural gas. The most well-known gas energy stock is Gazprom. Gazprom is the biggest natural gas company in the world and supplies mostly Europe and Asia via pipelines.
Renewable Energy Stocks
Renewable energy is on a huge rise, and becoming more and more important in the fight against climate change. To be considered a renewable energy stock, companies are usually involved in the production, distribution and sale of energy generated by renewable sources such as wind, solar and hydropower. Examples include Tesla, NextEra Energy, First Solar and Vestas Wind Systems.
What are Energy ETFs
ETFs or exchange-traded funds track an underlying market by investing in a basket of stocks related to a theme. For example, an oil ETF may invest in stocks related to the extraction, distribution and sale of oil. It allows investors to capitalise on a theme in a more diversified manner from just one investment.
ETFs can be bought or sold using a broker just like stocks, or traded via CFDs. Examples of some energy ETFs include:
How to Start Investing in Energy
Here are just a few steps to help you get started with energy trading.
1. Educate yourself: Read all the information you can find about energy trading. Learn the basics of the financial market and stay up to date with macroeconomic trends developing in the market through different live trading webinars.
2. Specialize in an energy market: It’s better to become an expert in one field and to specialise. Pick the energy market that captures your interest, it’s a great way of staying motivated and learning more in-depth knowledge.
3. Build an energy trading strategy: Identifying the rules and criteria you need to take a trade is essential in managing risk appropriately and being consistent. Learn more in the 6 Top Trading Strategies article which you can use to build your energy trading strategy.
4. Practice on a demo account: Before you trade live, practice first. A demo trading account will help you to practice your skills in a virtual environment until you are ready to go live.
FAQs on Energy Trading
What is energy trading?
Energy trading is the investing in or speculation of energy markets such as oil, gas, electricity and power.
What does an energy trader do?
Energy traders buy and sell energy commodities in order to try and profit from future price fluctuations in the market. They usually trade in crude oil, natural gas and renewable energy markets.
What are the risks of energy trading?
Energy trading risks are similar to those of other forms of investing such as extreme price volatility, unexpected geopolitical events and changes in supply and demand. Educate yourself about what influences the price of certain commodities and manage your risks accordingly.
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