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More About This Title Energy Trading and Risk Management: A Practical Approach to Hedging, Trading and Portfolio Diversification
English
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.
English
IRIS MACK, PHD, EMBA, earned a Harvard doctorate in Applied Mathematics and a London Business School Sloan Fellow MBA. She is a former MIT professor and Derivatives Quant/Trader who has worked in financial institutions in the U.S., London, and Asia. She has also spent some of her professional career at NASA, Boeing, and AT&T Bell Laboratories – where she obtained a patent for research on optical fibers.
Dr. Mack lectures and consults on energy derivatives, quantitative finance, and high frequency trading, and serves on various boards, including National Academy of Sciences Transportation Research Board, AlgoAnalytics Trading and Financial Analytics (India), MarketExpress Financial News and Research (India), Women Mentor Women Foundation, and I Can Still Do That Foundation.
Dr. Mack founded Phat Math Inc. and The Global Energy Post in Miami, Florida. She and her colleagues at Phat Math launched their prototype mathematics edutainment social network PhatMath.com. Students in grades K-12 and college have access to free 24/7 online math homework help on PhatMath.com — named one of the Top 50 Social Sites for Educators and Academics and 25 Useful Networking Sites for Grad Students.
To learn more about Iris and her website, please visit www.GlobalEnergyPost.com.
English
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
English
I instantly warmed up to the book barely a chapter in, struck by its practical approach, balanced tone, contextualised narrative and a genuine desire on the author’s part to define terms and methodologies for the benefit of those with a mid-tier investment knowledge base.
Furthermore, the instructive narrative seeks to bring about a holistic understanding of how energy markets work to begin with, leading on to an adequate treatment of risk, speculation and portfolio diversity tenets. The format in which 'Energy Trading and Risk Management' is minutely sub-sectioned point to point is simply splendid. So should you wish to salami slice and pick up bits of the subject, it would serve you just as well as a cover to cover read through.
Conversely, if you are confident enough to skip the basics and go straight through to concepts and formulas, the sequential flow of text in each chapter helps you breeze through basic definitions usually quoted in boxed text on to what you are after.
Accompanying the text are charts, case studies, background briefs, notes on macro drivers and definitions at various points split into ten weighty sub-sectioned chapters in a book of around 270 pages. From contango to the modern portfolio theory, from risk management in the renewables business to mitigation in an ever changing market climate – it’s all there and duly referenced.
While I appreciated Dr Mack's work in its entirety, a chapter on exotic energy derivatives (which follows a passage on the plain vanilla variety) stood out for me. One would be happy to recommend this title to energy professionals, fellow energy analysts and those with a desire to pursue energy trading as a career pathway.
It would most definitely appeal to entrants finding their feet in the market as well as established participants wanting to refresh their thinking and methodologies. Ultimately, for every reader this title is bound to morph from being an informative and educational book at the point of first reading, to an invaluable reference source as and when subsequently needed. That makes it worthy of any energy sector professional’s bookshelf.—Gaurav Sharma
