DerekW. Bunn

London Business School

The four papers in this issue discuss, in their different contexts, some of the most crucial aspects of energy risk at the moment. The geopolitics of European dependency upon Russian gas has been a key issue in the debate on energy security and hovers over all deliberations on longer-term power and gas prices in western Europe. In the opening paper, "Russian gas to western Europe: a game-theoretic analysis", Zweifel et al focus on modeling the transit game between Belarus, Ukraine and Russia. Considering both cooperation and non-cooperation, the predicted Nash equilibrium is a grand coalition. They observe that the completion of the North Transgas pipeline will benefit Russia decisively, to the detriment of Ukraine particularly.

Oil price risk is perhaps even more fundamental and, allied to the methodological issues raised by the recent credit crisis upon correlation analyses in general in risk management, the paper “Modeling conditional correlations for risk diversification in crude oil markets” by Chang et al is particularly timely. They estimate univariate and multivariate conditional volatility and conditional correlation models of spot, forward and futures returns from three major benchmarks of international crude oil markets, namely Brent, West Texas Intermediate and Dubai, to aid in risk diversification. The contribution of the paper is methodological and several approaches to conditional correlation models are undertaken. The estimates of volatility spillovers and asymmetric effects for negative and positive shocks on conditional variance suggest that vector autoregressive moving average–generalized autoregressive conditional heteroscedasticity (VARMA–GARCH) is superior to the vector autoregressive moving average–asymmetric generalized autoregressive conditional heteroscedasticity (VARMA-AGARCH) model. In addition, theDCCmodel gives statistically significant estimates for the returns in each market, which shows that constant conditional correlations do not hold in practice.

Cointegration analysis offers a more subtle form of modeling interactions, when it is applicable. In “Structural interactions of European carbon trading and energy prices”, Fezzi and Bunn found that a plausible cointegrating equilibrium did exist between power, gas and carbon prices in the middle of Phase I of the European carbon emission trading scheme and that the dynamic short-term error-correction models between the three commodities revealed a more precise explanation than simple correlations. Finally, in “Intra-day risk premia in European electricity forward markets”, Ronn and Wimschulte compute the intra-day risk premium and market price of risk for two well-arbitraged exchanges: the European Energy Exchange in Germany and the Energy Exchange Austria. Given the significant volatility and jump risk of electricity prices, these closely linked markets offer an opportunity to study whether market participants are willing to pay a premium to secure day-ahead delivery prices earlier in a trading day. Generally, a positive risk premium is found, leading to the implication that forward prices are upward-biased predictors of expected electricity spot prices. Overall, these four papers provide a timely and stimulating range of modeling and market insights.