A comprehensive overview of trading and risk management in the energy markets Energy Trading and Risk Management provides a comprehensive overview of global energy markets from one of the foremost authorities on energy derivatives and quantitative finance. With an approachable writing style, Iris Mack breaks down the three primary applications for energy derivatives markets Risk Management, Speculation, and Investment Portfolio Diversification in a way that hedge fund traders, consultants, and energy market participants can apply in their day to day trading activities. Moving from the fundamentals of energy markets through simple and complex derivatives trading, hedging strategies, and industry-specific case studies, Dr. Mack walks readers through energy trading and risk management concepts at an instructive pace, supporting her explanations with real-world examples, illustrations, charts, and precise definitions of important and often-misunderstood terms. From stochastic pricing models for exotic derivatives, to modern portfolio theory (MPT), energy portfolio management (EPM), to case studies dealing specifically with risk management challenges unique to wind and hydro-electric power, the bookguides readers through the complex world of energy trading and risk management to help investors, executives, and energy professionals ensure profitability and optimal risk mitigation in every market climate. Energy Trading and Risk Management is a great resource to help grapple with the very interesting but oftentimes complex issues that arise in energy trading and risk management.
Preface xiii Acknowledgments xxv About the Author xxvii About the Contributors xxix Chapter 1 Energy Markets Fundamentals 1 1.1 Physical Forward and Futures Markets 3 1.2 Spot Market 5 1.3 Intraday Market 10 1.4 Balancing and Reserve Market 10 1.5 Congestion Revenue Rights, Financial Transmission Rights, and Transmission Congestion Contracts 11 1.6 Chapter Wrap-Up 12 References 13 Chapter 2 Quant Models in the Energy Markets: Role and Limitations 15 2.1 Spot Prices 17 2.1.1 Random Walk Jump-Diffusion Model 19 2.1.2 Mean Reversion: Ornstein-Uhlenbeck Process 23 2.1.3 Mean Reversion: Schwartz Type 1 Stochastic Process 25 2.1.4 Mean Reversion with Jumps 25 2.1.5 Two-Factor Model 26 2.1.6 Negative Prices 27 2.2 Forward Prices 28 2.2.1 Forward and Futures Markets 28 2.2.2 Contango and Backwardation 30 2.3 Chapter Wrap-Up 31 References 31 Chapter 3 Plain Vanilla Energy Derivatives 33 3.1 Definition of Energy Derivatives 34 3.2 Global Commodity Exchanges 35 3.3 Energy Derivatives Pricing Models 36 3.4 Settlement 37 3.5 Energy Derivatives Quant Models: Role and Limitations 38 3.6 Options 40 3.6.1 Volatility 42 3.7 Vanilla Options 43 3.7.1 Option Style 44 3.7.2 Exchange-Traded and Over-the-Counter Options 44 3.7.3 In-the-Money, At-the-Money, and Out-of-the-Money Options 45 3.7.4 Put-Call Parity 46 3.8 European Options 47 3.9 American Options 50 3.10 Swaps 52 3.11 Swaps to Futures 54 3.12 Chapter Wrap-Up 54 References 54 Chapter 4 Exotic Energy Derivatives 59 4.1 Asian Options 60 4.1.1 Classes of Asian Options 61 4.1.2 Payoffs of Asian Options 62 4.1.3 Solutions to Asian Options 63 4.1.4 Asian Options in the Energy Markets 63 4.2 Barrier Options 63 4.2.1 Eight Types of Barrier Options 64 4.2.2 Partial Barrier Options 65 4.2.3 Solutions to Barrier Options 66 4.2.4 Barrier Options in the Energy Markets 66 4.3 Digital Options 66 4.3.1 Types of Digital Options 67 4.3.2 Solutions to Digital Options 69 4.3.3 Digital Options in the Energy Markets 69 4.4 Real Options 71 4.4.1 Real Options in the Electric Power Markets 71 4.4.2 Case Study: Real Options in the Oil Markets 72 4.4.3 Limitations of the Real Options Valuation Paradigm 73 4.5 Multiasset Options 74 4.5.1 Pricing Multiasset Options 74 4.6 Spread Options 75 4.6.1 Crack Spreads 76 4.6.2 Spark Spreads 82 4.6.3 Dark Spreads 85 4.7 Perpetual American Options 86 4.7.1 Perpetual American Options in the Power Industry 87 4.8 Compound Options 87 4.8.1 Tolling Agreements: Example of Compound Options in Power Markets 89 4.9 Swaptions 90 4.9.1 Energy Swaptions 91 4.10 Swing Options 92 4.11 Chapter Wrap-Up 94 References 94 Chapter 5 Risk Management and Hedging Strategies 99 5.1 Introduction to Hedging 102 5.2 Price Risk 104 5.3 Basis Risk 107 5.3.1 Basis Risk Case Study 108 5.3.2 Metallgesellchaft Case: Stack and Roll Hedging Disaster 109 5.4 The Option Greeks 110 5.5 Delta Hedging 111 5.6 Gamma Hedging 113 5.7 Vega Hedging 115 5.8 Cross-Hedging Greeks 116 5.9 Quant Models Used to Manage Energy Risk: Role and Limitations 116 5.9.1 Regression Analysis 117 5.9.2 Stress Test 120 5.9.3 Value at Risk 123 5.10 Chapter Wrap-Up 124 References 124 Chapter 6 Illustrations of Hedging with Energy Derivatives 127 6.1 Hedging with Futures Contracts 129 6.1.1 Case Studies and Examples: Hedging with Futures Contracts 130 6.1.2 Risks Associated with Hedging with Futures Contracts 138 6.2 Hedging with Forward Contracts 141 6.3 Hedging with Options 143 6.3.1 Case Study: Call Options Used to Set a Cap on Gasoline Prices 143 6.3.2 Example: How Power Generators Use Options on Futures to Hedge 144 6.3.3 Example: How End Users Utilize Options on Futures to Hedge 145 6.3.4 Example: How Power Marketers Use Options on Futures to Hedge 145 6.4 Hedging with Swaps 146 6.4.1 Example: Fuel Swap 148 6.4.2 Example: Electricity Swap 149 6.4.3 Case Study: Natural Gas Basis Swap 150 6.5 Hedging with Crack Spread Options 151 6.5.1 Case Study: Hedging with Crack Spread Options 153 6.6 Hedging with Spark Spreads 154 6.6.1 Case Study: Power Producer Uses Spark Spread to Protect Margin 154 6.7 Hedging with Other Energy Derivatives 157 6.8 Chapter Wrap-Up 158 References 158 Chapter 7 Speculation 161 7.1 Convergence of Energy and Financial Markets 162 7.2 Trading Terminology 167 7.3 Energy Products Trading Codes 169 7.4 Futures Trading Symbols: Month Code Abbreviation 170 7.5 Fundamental and Technical Analyses 171 7.6 Trading Tools: Charts and Quotes 173 7.7 Energy Trading Market Participants 176 7.8 Speculation in the Oil Markets 182 7.9 Speculation in the Electricity Markets 184 7.10 Speculation in the Natural Gas Markets 185 7.11 Chapter Wrap-Up 187 References 187 Chapter 8 Energy Portfolios 191 8.1 Modern Portfolio Theory 192 8.2 Energy Portfolio Management 196 8.3 Optimization of Electricity Portfolios 197 8.3.1 Case Study: Economic Load Dispatch of a Portfolio of Gas-fired Power Plants 199 8.4 Optimization of Gas Portfolios 201 8.5 Other Energy Portfolio Management Models 203 8.6 Chapter Wrap-Up 203 References 204 Chapter 9 Hedging Nonlinear Payoffs Using Options: The Case of a New Subsidies Regime for Renewables 207 9.1 Renewable Energy, Options Pricing, and Government Subsidies 209 9.1.1 Power Assets Modeled as a Vanilla Call Option 210 9.1.2 Strike Price of a Wind Turbine 211 9.1.3 Levelized Cost Price of Electricity 211 9.1.4 Wind Turbines Competitiveness on the Electricity Market 213 9.2 Government Subsidies as a Stochastic Process 216 9.3 Impact of Embedded Options and Stochastic Subsidies on Pricing and Risk Management 219 9.3.1 Pricing of a Wind Turbine and Subsidies as an Embedded Option 219 9.3.2 Tail Risk and Hedging Options with Options 222 9.4 Chapter Wrap-Up 224 References 225 Chapter 10 Case Study: Hydro Power Generation and Behavioral Finance in the U.S. Pacific Northwest 227 10.1 An Overview of Behavioral Finance 229 10.2 Behavioral Finance in Energy Economics 231 10.3 Power Generation in the Pacific Northwest 232 10.4 Behavioral Financing of Projects in the Pacific Northwest 235 10.5 Northwest Power Planning 239 10.5.1 Resource Availability 239 10.5.2 Resource Cost 239 10.5.3 System Flexibility 240 10.5.4 Cost Effectiveness 241 10.5.5 Transmission 241 10.6 Chapter Wrap-Up 241 Reference 242 Bibliography 243 Index 259
Accessing your eBook through Kortext
Once purchased, you can view your eBook through the Kortext app, available to download for Windows, Android and iOS devices. Once you have downloaded the app, your eBook will be available on your Kortext digital bookshelf and can even be downloaded to view offline anytime, anywhere, helping you learn without limits.
In addition, you'll have access to Kortext's smart study tools including highlighting, notetaking, copy and paste, and easy reference export.
To download the Kortext app, head to your device's app store or visit https://app.kortext.com to sign up and read through your browser.
NB: eBook is only available for a single-user licence (i.e. not for multiple / networked users).
