Spread bets
Why "energy transition assets" could drive commodity trading returns
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“The commodity traders are arbitragers par excellence, trying to exploit a series of differences in prices…They are, in the words of one academic, the visible manifestation of Adam Smith’s invisible hand.”
- Javier Blas, The World for Sale: Money, Power, and the Traders Who Barter the Earth's Resources
Commodity trading profits slumped from $100 billion during 2022 and 2023 to $72 billion in 2024, according to preliminary estimates by McKinsey. A return to a more ‘normal’ trading environment, characterised by lower and less volatile energy prices and fewer geopolitical disruptions, has dampened margins.
The adverse impact was greatest for those traders covering oil & oil products, and power & gas. The total margin generated across these two commodity sectors, which together normally account for two-thirds of the total, declined by almost 40% versus the period 2022/23.
The boom years marked by Russia’s invasion of Ukraine attracted new entrants into the market and incentivised existing firms to expand their operations. As uncertainty and price volatility has subsided, so the increase in competition has also acted to reduce the margins available.
The world for sale
Of course, commodity trading firms do sometimes take directional bets on the price of various commodities, but it would be incorrect to suggest that is their primary purpose. Commodity traders play an essential role in the global economy, ensuring that the resources we need on a daily basis - energy, raw materials, and food - are there when we need them.
A small number of huge commodity trading firms dominate the production, transportation and trading of commodities. Virtually all commodities must undergo a variety of processes to transform them into things that we can actually consume. These transformations can be grouped into the following categories: space, time and form.
The first transformation requires the transportation of commodities from where they are produced to the places they are consumed. The areas where commodities can be efficiently produced, such as fertile land or mineral deposits, are usually away from, and often far away from, where those who desire to consume them reside.
The second transformation requires commodities to be stored to correct for mismatches in the timing of production and consumption. Stocks can be accumulated when supply is unusually high or demand is unusually low, and can then be drawn down upon when demand exceeds supply.
Finally, commodities must often undergo transformations in form in order to be suitable for final consumption or for use as an input in a process further down the value chain. For example, crude oil must be refined into gasoline, diesel and other products.
Commodity trading firms seek to identify the most valuable of these transformations, undertake the transactions necessary to make these transformations and engage in the physical and operational actions necessary to carry them out (see Know your onions: Concern over the role of speculators in Europe's energy markets is overplayed).
Right now, the returns from these transformations are under pressure, but that’s not expected to last long. Taking a longer-term view, McKinsey are forecasting a return to a steady margin growth (~10% per annum) with overall industry profit expected to return to $100 billion before the end of the decade.
Power, gas, and LNG markets are likely to drive much of the increase, supported by market liberalisation, the growth in electricity demand (+3.5% per annum), and weather related volatility as renewable adoption rises. McKinsey also expects “energy transition assets”, such as carbon credits, biofuels, energy attribute certificates (EACs), and green premium certificates (GPCs) to be a major source of growth.1
Let’s take a look at the opportunity for commodity traders across each of the four markets.