Energy trading and speculation

An article in the NY Times on Sunday entitled "Energy Trading, Post-Enron" gives you a glimpse of the sheer magnitude and  frenzy associated with energy trading and speculation. Hedge funds are into it. Even big boring banks are into it. Big Wall Street  investment banks are big players as well. Obviously there is lots of money to be made here.

And where does all of that money come from? Does it come out of a bunch of holes in the ground? Does it come out of thin air? Nope. It comes directly out of the pockets of energy consumers, whether they be consumers buying retail gasoline, heating oil, and natural gas, electricity producers and consumers, airlines, transportation companies, chemical companies, and on and on. That's why there is so much money to be made in trading and speculating on energy and related commodities: it's like a zillion giant sunction hoses connected up to every wallet in America (and beyond), corporate and personal.

Will it never end and only get worse (or better if you're an energy trader)?

Well, the saving grace is that with the arrival of hedge funds and a true trader's mentality and prices that have been starting to cause people some pain to the point where they seek to cut their energy usage, the concept of "shorting" energy for short-term trades will grow in appeal. It's a simple fact that traders love trading ranges. No true trader worth his salt is willing to bet on a one-way market forever. Up and down and up and down, that's that true traders like to see. Each change in direction is a new opportunity for a profitable new trade. You're seeing this volatility now with natural gas prices.

A significant amount of the run-up in energy has been due to a combination of the arrival of new players (traders and speculators) and the arrival of a lot of misguided souls who have been led to believe that energy and commodities are a one-way, long-term, buy-and-hold investment. It's beginning to look an awful lot the stock boom in 1999 and early 2000.

It will be interesting to see how it all plays out over the coming months, with "investors" expecting commodities to only go up, and traders and hedge funds seeking to maximize volatility and transaction volume so that they can maximze profits regardless of the ultimate, long-term trend.

You can read our Stock Market Outlook for 2006 and our Daily Stock Market Commentary.

-- Jack Krupansky