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Why are energy commodities like coal trading up right now?

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Energy commodities spiked over the last year with analysts suggesting they could remain elevated over the next 12 months.



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Disclaimer: General information only. All forms of investments (in particular, trading CFDs, commodities & forex) carry significant risk, including the risk of losing more than the invested amounts, market volatility & liquidity risks. Past performance is no guarantee of future results. Such activities are not suitable for most investors. Seek independent advice and consider the PDS and TMD on the provider's website before making any trades.

The ever-growing focus on mitigating climate change has failed to slow down the coal sector, with governments especially in Europe increasing their burning of fossil fuels.

As such, 2022 has actually been one of the better years for energy commodities including coal and crude oil.

To help explain why the prices of commodities are skyrocketing, Finder has teamed up with Saxo to shed light on how some traders take advantage of this trend.

Why are coal and energy prices so high?

Prior to the coronavirus pandemic, the price of thermal coal was languishing around US$65 a tonne.

But fast forward to September 2022, prices at Australia's Newcastle port hit an all-time high around US$460 a tonne. The mineral known as "black gold" is set to end the year still above US$400 a tonne.

It's a similar story for crude oil, which is at a 10-year high of US$121 a barrel in March this year.

"We still expect there will be strong demand for all types of commodities well into 2023 given that the global inflationary environment doesn't seem to be abating any time soon," says Saxo Markets Australia CEO Adam Smith.

Part of the reason for the price surge in these commodities has been the role of China, by virtue of being the world's largest consumer of energy.

At the same time, the Asian giant curbed its coal production in an effort to control growing pollution in major cities.

But the biggest trigger to the rally came earlier this year when Russia decided to invade Ukraine, sparking an ongoing conflict in Europe and resulting in a completely changed geopolitical landscape.

Russia is the world's second biggest energy exporter, supplying around 7 million barrels a day of oil and refined products, and 30 million tonnes a year of liquefied natural gas (LNG).

But the conflict resulted in strict economic sanctions from Western countries on energy imports from Russia, resulting in worldwide shortages and saw European countries switch to coal.

How long will the commodities rally last?

When it comes to commodities like coal, you have to remember the world is shifting away from these resources, with businesses reluctant to add more supply.

Now, higher prices have relieved pressure on coal producers with many looking to revive projects that had been abandoned earlier.

But getting supplies into the market will take years.

Producers are also wary of the short time frame to recover costs on expensive projects, especially with just about every major economy committed to phasing out fossil fuels by 2050.

Ironically, this comes at a time when coal demand is expected to spike.

Earlier this month, a report by the International Energy Agency (IEA) predicted that global coal consumption is set to rise to an all-time high in 2022 and remain at similar levels in the next few years if efforts are not made to move to a low-carbon economy.

The IEA has forecast that global coal use is set to rise by 1.2% to exceed 8 billion tonnes in a single year for the first time in history.

It further estimates that coal consumption will remain at that level until 2025, with strong demand in emerging economies out of Asia making up for falls in mature markets.

"As the global economy looks to transition away from fossil fuels and into green energy it is a well known fact that energy commodities such as coal, gas and oil and industrial metals such as copper are required to facilitate the green transformation so demand should remain strong for some time yet," Saxo's Adam Smith said.

That means coal prices could stay strong next year and could possibly remain at elevated levels for the next few years.

Most analysts expect coal to trade above the US$300 a tonne range for most of 2023.

How can investors speculate on energy commodities?

Australia has been one of the biggest beneficiaries of this price rally, thanks to its commodities-export-heavy economy.

In July, coal became Australia's largest exported commodity, displacing iron ore from its hallowed position and helping widen the country's trade surplus.

Investors in ASX coal stocks such as Whitehaven (ASX: WHC), New Hope Corporation (ASX: NHC) and Yancoal have seen the value of their investments more than double over the last 6 months.

It's a similar story for Australia's 2 biggest oil & gas companies Woodside (ASX: WPL) and Santos (ASX: STO), which have surged as oil prices stayed above US$100 a barrel for months before easing.

However, the biggest advantages for traders lie in directly participating in commodities markets when they are in an upcycle, particularly during periods of high inflation.

Historically, commodity returns have a positive correlation with high inflation, unlike shares or bonds. This also means that energy commodities currently provide a natural hedge against rising prices.

Saxo's Adam Smith says an exposure to commodities could be a smart decision for investors and traders alike.

"Commodities of all types (wheat, coal, oil, gold, copper etc) tend to perform well in inflationary environments as do a lot of real assets and we see no reason that this could not be the case again in 2023."

In addition, commodities as an asset class can help investors to diversify their portfolio.

Diversification offers a form of protection against one asset class under-performing and helps smooth overall volatility in a portfolio.

There are several ways to invest in commodities including through shares, exchange-traded funds (ETFs) and contracts for difference (CFDs).

Commodities futures

Let's deep dive into the latter and talk about CFDs.

These are futures contracts – which are derivative contracts that allow trading at the current price for a later date.

Example: If you believe the price of oil will increase over the next 6 months, you can trade an oil futures contract and "buy" at the current price. If the price of oil does increase when the contract expires after 6 months, you can then sell the contract at higher prices and make a tidy profit.



Saxo Markets offers access to more than 300 futures from 28 global exchanges, covering equity indices, energy, metals, agriculture, rates and FX. Futures for energy commodities include multiple types of contracts on crude oil, natural gas, ethanol, the S&P GS Commodity Index, carbon, UK and European emissions.

Saxo offers Futures traded in Australia, the US and Europe so has pretty much all markets covered.

"One of the benefits of using Saxo is the breadth of Futures products that it offers in commodities (agricultural, energy, metals etc) and other asset classes such as Equities and FX," Mr Smith says.

You can trade futures at Saxo Markets via your desktop or mobile. To start trading futures at Saxo Markets, click here to create an account.

Alternatively, if you believe the price of oil will decrease over the next 6 months, you can sell the futures contract before it expires and buy it back when the price drops, at a profit.

While futures and CFDs are somewhat similar products, futures hold an inherent advantage over CFDs.

Futures are created and traded on exchanges, which means their prices are established by the market. By comparison, CFDs are derivative instruments created by brokers, so their prices are also derived by brokers. With CFDs, you don't own the underlying asset, though your position is tied to the price of stocks, commodities, indices, etc. that they represent.

This generally means that futures prices tend to more closely reflect the value of the underlying asset.

Disclaimer: This information should not be interpreted as an endorsement of futures, stocks, ETFs, CFDs, options or any specific provider, service or offering. It should not be relied upon as investment advice or construed as providing recommendations of any kind. Futures, stocks, ETFs and options trading involves substantial risk of loss and therefore are not appropriate for all investors. Trading CFDs and forex on leverage comes with a higher risk of losing money rapidly. Past performance is not an indication of future results. Consider your own circumstances, and obtain your own advice, before making any trades. Read the Product Disclosure Statement (PDS) and Target Market Determination (TMD) for the product on the provider's website.

Futures can also offer significant savings on transactional costs as they are traded on markets, and as such represent a more cost-efficient way of doing business. For example, e-Micro and Mini Futures available on trading platform Saxo are more affordable and accessible than CFDs.

"We have clients that trade both Futures and CFDs, so it usually comes down to personal preference and experience - understanding the complexities of Futures compared to CFDs. For instance, Futures can provide traders and investors with a cheaper and more capital efficient way to trade the global markets on margin," Mr Smith said.

Risks associated with futures contracts

Leveraged losses: Because futures contracts only require a margin payment at the time of trading, if the commodities price moves unexpectedly, it can magnify losses and you may lose more than you've invested.

Trading costs: Futures trading usually involves a commission cost, with some fees to be paid each time you trade. These have to be factored into overall profit/loss calculations.

Volatility: There are never any guarantees in financial markets. Commodities in particular are often affected by factors such as weather, natural hazards and geopolitical events. Investors must accept the risk that they won't always come out on top despite taking precautions.

Complex: Futures contracts aren't easy to understand. Compared to stocks, the underlying dynamics of futures aren't as easy to grasp. Investors must make sure they understand the market, its risks, and the way Futures are structured and traded before trading Futures contracts.

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