Trading in a New Energy Ecosystem

The global energy landscape has changed dramatically over the past decade, which has affected all aspects of energy trading, including how, when and where capital is allocated.

While the context in which financial institutions allocate capital is constantly shifting, some clear megatrends have emerged and are here to stay. It is evident that they are making the market more complex and unpredictable. The market needs access to vast credit capital in the form of bank debt and institutional investors, as well as deep industry knowledge coupled with modern and digital treasury technologies.

The most profound megatrend is the energy transition, as nations work to decarbonize their economies in response to the imperative to limit the impacts of climate change. Governments around the world have made commitments to net-zero emissions by 2050, or shortly thereafter, and this has led to significant changes in energy and carbon policies.

Emission reduction targets are backed by government policies encouraging the rollout of clean and renewable energy technologies—principally wind and solar—and electric vehicles, and the development of low-carbon fuels such as green hydrogen. The US, for example, aims to cut greenhouse gas emissions to 50%–52% below 2005 levels in 2030, reach 100% carbon pollution-free electricity by 2035 and achieve a net-zero emissions economy by 2050. The US Inflation Reduction Act provides an estimated $400 billion to incentivize clean energy, support electrification and energy-efficiency measures, reduce methane emissions, promote domestic manufacturing and supply chains, and address environmental justice.

The global clean energy rollout is happening at an astonishing pace, and is transforming energy systems and the mix of energy resources that countries are deploying. According to the International Energy Agency, “global additions of renewable power capacity are expected to jump by a third this year,” and “growth is set to continue next year with the world’s total renewable electricity capacity rising to 4,500 GW, equal to the total power output of China and the United States combined.” Access to finance needs to be routed through agile market participants who can react to market trends, as well as predict trends and opportunities. Banks, such as J.P. Morgan, have specialized advisory units that continue to probe new trends to ensure their product suite and deployment meet the latest market developments.

Decarbonization is being achieved by replacing fossil fuel power generation with renewable energy, and by the electrification of key areas of the economy including mobility and heat. This is driving demand for a range of new energy products, ranging from wind turbines to sustainable aviation fuel and biofuels, and many energy companies are now moving into new industries, including renewable power, electric vehicle charging infrastructure and the raw materials used to produce them. They are also increasingly trading electricity itself, generated by assets they own as well as by third-party power providers.

These new products, and the commodities required to produce them, including lithium, cobalt, manganese and rare earths, have vastly different demand profiles and capital requirements than traditional energy markets. They also carry a different risk profile than traditional sources of energy, which, from a financing perspective, provides a challenge in terms of managing production, liquidity and country risk. Financing is required to build and operate these facilities, which requires the involvement of banks with global scale.

The carbon credits market will be an important tool for enabling the low-carbon transition to occur at a pace and scale commensurate with the climate challenge, and to help drive investment in the technologies needed to address emissions in hard-to-abate sectors of the economy. It can also play a role in speeding the development and commercialization of new technologies, such as direct air capture and bio-oil sequestration, which are needed to further accelerate progress toward net-zero emissions.

Earlier this year, J.P. Morgan Chase signed long-term agreements to purchase over $200 million in high-quality, durable carbon dioxide removals. These agreements, intended to remove and store 800,000 metric tons of carbon dioxide equivalent (CO2e) from the atmosphere, represent one of the largest carbon removal purchases announced to date.

Demand will increase for a number of well-established commodities, including steel, aluminum, copper, silicon and nickel. Under BloombergNEF’s Net Zero Scenario, demand for copper from transition-related technologies will rise from 6,425 metric tons in 2022 to 38,301 metric tons by 2050, while demand for lithium, nickel and manganese from these technologies will each rise more than tenfold in the same period.

In the same way that certain countries dominate the production of oil and gas, new players, such as Chile, Indonesia and Australia, are emerging that will have a vital role in providing the materials on which the energy transition will be built. The Democratic Republic of Congo holds 48% of the world’s cobalt reserves, while 90% of platinum group metals (PGMs) and 38% of manganese reserves are in South Africa, reports BNEF.

Developing metal mining projects can take decades, and how these materials are traded, transported and stored is quite different from transporting oil or LNG, with different capital requirements. Outside of commodity markets, innovative financial products for the energy transition include green bonds, carbon credits and power purchase agreements (PPAs).

At the same time, measures such as carbon pricing and the EU’s Carbon Border Adjustment Mechanism are reducing demand for the coal, oil and gas that have driven the creation of the modern world. However, demand remains strong in certain markets, particularly in Asia.

All these shifts have revealed supply chain pressure points—from high demand for rare earth minerals needed for clean technologies, to lenders restricting their funding of fossil-fuel producers—that are making access to capital more costly and unpredictable. And the commodities markets are generally less sophisticated and liquid than oil and gas markets.

While the energy transition will be the key driver of energy markets in years to come, it is not the only factor, and other pressures are not always pulling in the same direction. Ongoing tensions between the US and China, and concerns about the concentration of certain minerals and processing capacity within particular countries, are prompting many nations to try to diversify their energy transition commodity supply chains to make them more secure.

The Inflation Reduction Act, for example, provides significant subsidies for electric vehicle batteries and the raw materials within them that are produced in countries with free-trade agreements with the US.

Meanwhile, the conflict in Ukraine has brought renewed volatility to global energy markets, increasing demand for oil and gas. It is also hastening secular demand shifts, with, for example, the EU accelerating plans to decarbonize its economy, as high energy costs boost demand for clean energy alternatives.

The shifting landscape of government sanctions has brought a new unpredictability to the trading of key commodities, and the impact has both contributed to and been exacerbated by inflationary pressures and higher interest rates.

On top of all this, an increasing number of extreme weather events such as floods, wildfires and heat waves are disrupting production and trade flows around the world.

These new levels of volatility have introduced new levels of uncertainty and stress into the energy trading system. Having sufficient working capital available is crucial to meet margin calls and settlement obligations, as is having enough cash available to provide a buffer against unexpected shocks.

All these factors are making energy trading more complex, at a time when it has a crucial role to play in the energy transition—ensuring that the materials and clean energy vital to our efforts to reduce emissions get to where they need to go.

“Energy traders are crucial to the energy transition because they are best placed to match suppliers with the changing needs of consumers,” says Tristan Attenborough, Managing Director of Global Head of Energy, Power, Renewables and Metals/Mining for J.P. Morgan Payments. “But as the energy mix changes and volumes grow, the liquidity required to support trading activity will need rethinking.”

Energy markets require significant amounts of liquidity, new financial instruments and sophisticated banking support to advise and fund the staggeringly large investments required for the transition. Banks need to understand the future challenges in order to deploy their capital efficiently, as well as to attract investments in from international capital markets. Banks also need to be well positioned with all types of investors to ensure that the right projects attract the right kind of investment. This will allow sustainable finance to make a difference, as well as make a return.