Abstract
Most of the risks in energy production and trading are related to market prices. As a consequence, this first chapter provides a short introduction to energy markets. Products (or more precisely contracts) which are traded in energy markets can concern either the physical delivery of energy (physical settlement) or only the payment of the financial value of such a delivery (financial settlement). In the case of a physical settlement, the traded quantities directly influence the whole system; if the settlement is financial, trades are basically bets on prices. Motivated by this distinction, we separate this chapter into two major parts: The first part considers the physical side of markets, focusing on the physical spot markets for natural gas and electric power. The second part serves as an introduction to the financial aspects of the markets, describing derivatives on physical spot contracts. In both sections our geographical focus will be on European markets. Due to the inhomogeneities of market designs, we will focus on stylized market characteristics rather than details. We mainly consider natural gas and electricity due to their distinctively different behavior to financial markets.
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- 1.
For details on the rationale behind energy market liberalization we refer to [22].
- 2.
That is mature, liquid markets, allowing to execute trades of arbitrary size at quoted prices (cf. p. 18).
- 3.
cf. [8].
- 4.
For example, the emergence of cheap USA shale gas around 2010 did not lead to significant exports of natural gas to other continents. However, market prices outside the US still dropped, to some extent caused by LNG transports stopping to deliver to the USA and serving the rest of the global market instead [1].
- 5.
One of the major drivers behind the large-scale usage of natural gas was to diversify energy consumption from oil in the oil crises in the 1970s, see [8].
- 6.
For example, NBP in Great Britain or the NCG and GP in Germany.
- 7.
For example, outages of the interconnector between GB and continental Europe or hurricanes blocking the natural gas infrastructure in the gulf of Mexico.
- 8.
At the moment consisting of Germany, France, the Netherlands, Belgium, Italy, Austria, and Denmark.
- 9.
Such as in the PJM market area at the east coast of the USA.
- 10.
For details we refer to the webpage of the PJM system operator: www.pjm.com.
- 11.
This relation is the fundament of the so-called hybrid or structural price models which merge equilibrium and econometric models. Cf. [7] for a detailed discussion.
- 12.
The validity of this assumption is debatable, for example, due to strategic bidding by the producers.
- 13.
According to [4], freight rates sometimes amount to 70% of the coal price.
- 14.
Usually the contract size times length of the delivery period.
- 15.
Initial margin.
- 16.
We assume no interest rate and ignore initial margin for the sake of simplicity.
- 17.
= 10 MW×(24×31)h×0.17 d’/MWh.
- 18.
A famous example is the case of the hedge fund Amaranth Advisors L.L.C., which collapsed, unable to liquidate its huge portfolio of natural gas futures (cf. [5]).
- 19.
Not necessarily unique; see discussion at the end of Sect. 1.3.3.
- 20.
For details see European Federation of Energy Traders, http://www.efet.org/ or International Swaps and Derivatives Association, http://www2.isda.org/.
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Gross, P., Kovacevic, R.M., Pflug, G.C. (2013). Energy Markets. In: Kovacevic, R., Pflug, G., Vespucci, M. (eds) Handbook of Risk Management in Energy Production and Trading. International Series in Operations Research & Management Science, vol 199. Springer, Boston, MA. https://doi.org/10.1007/978-1-4614-9035-7_1
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