Volume 3, Number 4 (December 2010)
Derek W. Bunn
London Business School
Three years after its conception, The Journal of Energy Markets appears to be fulfilling its promise as the journal of choice for researchers and analysts taking model-based approaches to understanding the dynamics of energy market behavior and, accordingly, the decision strategies that participants may need to formulate. The flow of papers has become substantial, with several annual workshops in this area focusing upon the Journal of Energy Markets as their publication outlet. This final issue of 2010 offers a good balance between the decision-technology and market-dynamic aspects of the subject area, positioned at the interface between theory and practice.
Thus, in the first paper in the issue, “Evaluation of static hedging strategies for hydropower producers in the Nordic market”, by Fleten et al, we see an optimization model derive static hedge positions for hydropower producers with different risk characteristics. Theoretical research has primarily considered dynamic hedging. However, static hedging is the common choice among hydropower producers because of its simplicity. The contribution of this paper is to evaluate such hedging out of sample. The results show that, although optimized positions vary over time, hedging with use of forward contracts significantly reduces the risk in terms of value-at-risk, conditional value-at-risk and the standard deviation of the revenue. Furthermore, this improvement comes at the cost of just a minor reduction in the mean revenue. In the second paper, “LNGScheduler: a rich model for coordinating vessel routing, inventories and trade in the liquefied natural gas supply chain”, by Fodstad et al, we see another optimization model. This provides decision support for the LNG supply chain by coordinating vessel routing, inventory management upstream, onboard and downstream, trading, and contract obligations. The model maximizes profit by utilizing different trading contracts, seasonal variations in pricing, price differences between different markets and inventory routing. The paper looks into how the model may suggest changes to some of the common business practices in the industry.
Turning from optimization-based decision modeling to models of market price dynamics, the third paper in the issue, “Oil price formation through unstable, inelastic demand and cartel imperatives”, by Hwang et al, generalizes a theoretical price formation model through both the demand and supply functions of the OPEC cartel. The cartel’s pricing policy is largely affected by its aggregate demand curve and related elasticities. Market equilibrium is shown to be self-adjustable under the stable case. The unstable case has helped explain the divergence and, therefore, greater volatility in prices and uncertainty in the oil market. Finally, estimation of the elasticity of oil demands in the US market (the world’s largest energy consumer) is shown to have some influence on movements in the market price of crude oil.
In contrast to crude oil price dynamics, the fourth paper, “Model specification analysis in the methanol markets”, by Cummins et al, fills a research gap on spot methanol prices with an analysis of the European and US markets.A model specification analysis is performed on a suite of models, incorporating jumps and/or stochastic volatility, from which a stochastic volatility jump-diffusion model performs best. Modeling insights for the fair valuation of embedded derivatives and for front-office structuring of methanol-based derivatives are suggested.
We think that these four papers continue to indicate the range and quality of modelbased insights into energy markets that the Journal of Energy Markets is fostering, and particularly they demonstrate the relevance of research for professionals as well as for researchers working in this sector.
Papers in this issue
Oil price formation through unstable, inelastic demand and cartel imperatives
LNGScheduler: a rich model for coordinating vessel routing, inventories and trade in the liquefied natural gas supply chain
Evaluation of static hedging strategies for hydropower producers in the Nordic market
Model specification analysis in the methanol markets