Basis risk is the risk that the value of a futures contract (or an over-the-counter (OTC) hedge) will not move in line with that of the underlying exposure. Alternatively, it is the risk that the cash futures spread will widen or narrow between the times at which a hedge position is implemented and liquidated.
There are various types of basis risk. For example, a heating-oil wholesaler selling its product in Baltimore will be exposed to basis risk if it hedges using New York Harbor heating oil futures contracts listed by Nymex. This is a ‘locational’ basis risk.
Other forms of basis risk include ‘product’ basis, arising from mismatches in type or quality of hedge and underlying (for example, hedging jet fuel with heating oil); and ‘time’ or ‘calendar’ basis (for example, hedging an exposure to physical prices in December with a January futures contract).
The Energy Risk Glossary, now in its eighth edition, provides an at-a-glance explanation of the myriad specialised terms and acronyms used in energy trading and risk management.
This year, the guide has been updated by Aviv Handler of ETR Advisory. Energy Risk would like to thank him for his input into this edition, which benefits greatly from his valuable experience and insight into energy markets.
The fast-changing nature of these markets means much has changed since our last edition – almost 200 new entries and revisions have been made this year. Reflecting the increasing importance of regulation, definitions of the Markets in Financial Instruments Directive (MiFid) and the Ljubljana-based Agency for the Cooperation of Energy Regulators (Acer) make it into the glossary for the first time. A focus on improving back-office infrastructure and mitigating counterparty risk is also apparent from the inclusion of terms such as ‘portfolio reconciliation’ and ‘portfolio compression’.
The glossary is extensively cross-referenced, making for easy and thorough searches. We hope you find it useful.
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