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What are Energy Derivatives?

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  • Written By: A. Leverkuhn
  • Edited By: Andrew Jones
  • Last Modified Date: 13 September 2016
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In the financial world, energy derivatives are securities or financial products that are based on energy assets. In general, a derivative is any securities contract or similar investment agreement based on an underlying asset. Many energy derivative options are based on petroleum or crude oil, but as fuel sources diversify, other kinds of energy derivatives attract investors as well.

Some experts identify futures and swaps as the major kinds of energy derivative types on common markets. A futures derivative is a contract to deliver some asset at a future date. Again, with energy derivatives, this often means investing in oil.

One relatively new kind of energy derivative product is an ETF or exchange traded fund. An exchange traded fund is a combination of various single energy securities, put into a package for automatic diversification. These kinds of products appeal to investors who want to put money into energy while limiting their risk.

Experts point out that investment in energy derivatives isn’t just for individual investors. Major trading firms and financial institutions often have interests in these financial products. Energy derivatives provide an entrance into an important and volatile market based on global trade and other factors.

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Finance pros also point out various strategies that investors usually have in mind when using energy derivatives. One example is “risk management,” where a company or party may actually wants to provide for less risk when they are actively engaged in buying and using energy commodities like oil or natural gas. In these cases, the parties will buy into complicated energy derivative products to be able to benefit from specific changes in the prices of these assets, for example, buying short positions so that if the price of energy products goes up, they will profit from investments even while they have to pay more for their supplies.

In addition, some investors speculate on energy price with derivative products. Long or short term speculation has become a major part of the action on lots of commodities including energy commodities. Energy derivatives are just one way to get involved in a marketplace that features a lot of “casino-style” short term trading, while also including more structured investments. The vast diversity of energy derivatives trading events shows how variable trading practices are, across the board, for any actual commodities or assets such as food, precious metals, or anything else the can be bought and sold in major modern global exchanges.

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