Energy Risk/Technical paper
Cutting edge: Modelling the correlation function in the crude-oil futures market
Energy market participants often require the computation of coefficients of correlation in a multi-asset portfolio. Addressing crude oil futures contracts, Ehud Ronn proposes and implements a simple procedure to reduce the cross-maturity correlations in…
Risk Management After Lehman
Can the constants used by quants and risk managers be trusted in the post-Lehman environment? Chris Schlegel of Southern Company looks at some of the pitfalls risk managers need to look out for when using constants and assesses why they are both vitally…
Cutting edge: Visualising value-at-risk
Risk transparency is an important yet elusive goal of any risk management process. One challenge is to understand the diversification effects of the portfolio elements. Wentao Zhao and Kevin Kindall introduce a graphical technique based on value-at-risk…
Masterclass: Valuing generation assets using Monte Carlo simulation
In this Masterclass, Les Clewlow, James Lujun Liu, Doug Meador, Ron Sobey and Chris Strickland describe the use of Monte Carlo methods for valuing generation assets in more detail. In particular, they discuss the appropriate price models to use and how…
Purchase timing
Managing purchase timing risk is a constant issue for wholesale power buyers. Pavel Diko reviews products that reduce this risk, proposes a lookback option that can eliminate it completely and outlines a hedging strategy for the option writer
Electricity-backed security: concepts and measures
John Jiang and Hanjie Chen propose a generic concept ofelectricity-backed security, which provides an additionalfunding method to utilities with poorer credit ratings,and a new asset class to investors
Gas portfolio and transport optimisation
Deciding which instruments to use to balance gas flows is not easy. Gido Brouns and Alexander Boogert discuss how to achieve gas portfolio optimisation by integrating this with the various gas transportation options available
Correlation and credit VAR
Navneet Arora and Shisheng Qu show that credit VAR in commodity trading is affected not only by the inherent credit risks of counterparties, but also by various correlations among counterparties and between counterparties and commodity prices
Trading opportunities in the Nymex frac spread
This article examines the long-term relationship between natural gas and propane futures. Using a technique known as 'frac' spread trading, Mbodja Mougoué and Steven Slack illustrate the opportunities that can occur from using the price fluctuations in…
Modelling natural gas futures returns
In this article, Mats Kjaer and Ehud Ronn propose and estimate the correlation matrix of natural gas futures returns. They describe the relationship between the correlation and the time between two contracts' maturities, along with the number of 'April'…
Using options theory for commodity spreads
Market risk for a real option asset can be effectively managed using a spread option model. Raymond Cheng and Walt Tyrrell demonstrate the enhanced risk-adjusted performance of optional refinery capacity with a historical back test
Delta hedging the load-serving deal
In this article Andrew Klingler takes a closer look at the residual risk when a load-serving contract is hedged with forwards. The residual risk components are described quantitatively and a formula for the minimum variance hedge is outlined
Forward thinking for backwardation
In certain settings it's reasonable to assume that the current futures price embodies the market expectations of the spot price. However, as Gary Dorris, Sean Burrows and Vena Kostroun explain, there are distinct situations when this assumption does not…
Empirical electricity price modelling
Hanjie Chen and John N. Jiang discuss how system-wide load-capacity ratio and system-wide generation forced outages impact day-ahead electricity spot price and show how to incorporate these two key factors in the price modelling
A model of time-varying volatilities in futures contracts
Despite the utility of forward price models in the risk management framework, models of spot prices are used more prevalently. Ted Kury presents a tractable model with time-varying volatility, that allows for temporal changes
Pricing illiquidity in energy markets
Illiquidity is sadly a typical feature of many energy derivative markets. In this paper Stefano Fiorenzani proposes the application of a methodology, originally developed for equity markets, to overcome this problem
Hedging weather exposure
Volumetric weather risk is usually levered by the commodity price, resulting in cross-commodity exposure known as a quanto. Hedging such exposure with quanto instruments is costly. Victor Dvortsov suggests a simple strategy that allows efficient hedging…
At the flick of a switch
Jesper Andreasen and Martin Dahlgren present a regime-switching model for electricity derivatives that incorporates spiky spot-price dynamics and allows for closed-form pricing of forwards, options and swaptions
Nuclear fusion R&D
In 50 years, nuclear fusion may be a major source of energy, but until then extensive research and development is needed. To justify the current and future R&D expenditure, a cost-benefit analysis designed specially for this sector is required. David…
A matter of principal
Developing term structure models can be tricky, as unknown factors and non-observable variables can affect futures prices. But principal components analysis is useful in tackling these problems. Here, Delphine Lautier uses PCA to pin down price movements…
Understanding Sam
The Samuelson Effect – backwardation in the term structure of forward volatility – can lead to valuation inaccuracies. In capturing the Samuelson Effect in energy derivatives valuation, analysts have tried both historical approaches and those that rely…
Risk-adjusted planning
An energy firm’s economic performance can be highly affected by incorrect valuation of implied economic risk. For this reason it is essential to provide management with the correct risk assessment tools. Here we propose a way of introducing risk…