Volatility in Energy Markets. Measures of Volatility Oil Gas Electricity Permits

Transcription

1 Volatility in Energy Markets Measures of Volatility Oil Gas Electricity Permits

2 Measures of Price Volatility Standard Deviation σ 2 σ Variance Empirically for a sample size T: T 1 σ : = T 1 t= 1 ( ) 2 x t x

3 O I L WTI

4 More Recent data

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6 Oil price determination- historical The history of the oil market has seen different price arrangements (in chronological order): Posted prices: Prices were posted as reference for the tax revenues (plus royalties) to be paid by the major oil companies. This system was in place until 1973 and although OPEC was founded in the sixties, it could only moderately increase the posted price until the Yom-Kippur war. This system was clearly favouring the oligopoly of the seven sisters that controlled the entire supply chain from the field to the pump. The introduction of the OPEC reference price (based on Arab Light with its up 5mb/d providing something like a residual resource) turned the table now favouring the OPEC oligopoly but working at the expense of Saudi Arabia upholding the price, which brought it for that reason down in Netback pricing. Crude oil price deals were made on the realizations of product prices in established spot markets (such as Rotterdam, Singapore and New York), which was disliked by OPEC due to the low price realizations. Current system of market related pricing that is related to the reference crudes WTI, so called Brent und Dubai.

7 Current Oil Price determination (Mabro) The marker prices are determined in two futures exchanges: NYMEX in New York and IPE in London. OPEC attempts to influence price by signalling its price preferences, by altering the level of its policy-determined production ceiling (and the associated production quotas). Those that buy or sell futures contracts may or may not respond to the signals. A positive market response to an OPEC (production) signal depends on how credible (that is how realistic) the OPEC policy decision appears to be. An OPEC decision on production is one, among several factors, that exercises an influence on the market. It often carries much weight but can be neutralised in certain instances by other factors sufficiently powerful to move the market in another direction. In other words the general market context is of significance and it is always essential to assess an OPEC policy decision within this context, not in isolation. Both OPEC and the market continually assess the world petroleum situation, i.e., the likely future movements in supply and

8 Oil markets Characteristics of Spot / Forward / Futures / Options Deals A futures contract is an agreement between two parties to buy or sell an asset at a certain future time for a certain price. A spot contract is an agreement to buy or sell an asset today. Forward contract is an agreement between two parties to buy or sell a specific asset at a certain future time for a certain price agreed today. It is traded in the OTC market, while futures are traded at an exchenge. Less than 5% of futures contracts result in physical delivery. A futures holder normally has the opposite position in the market, so that the two contracts cancel out.

9 Spot markets The original functioning and creation of the spot market was (and to some extent still is) to swap the mismatch of either of volume (too high or too low) or quality (say lighter crudes to meet high gasoline demand as in the US) between contracted crudes and product demand. The reason is that prior to 1973, the international oil companies ran an integrated network from the oil fields to the gas pump, as mentioned above. After 1973 and the subsequent nationalization of the oil reserves in most oil producing countries, the establishment of independent freight and refining business, the power of the companies was broken. As a consequence long term contracts replaced partially yet not completely the former control of supply and the share of crude acquired at the spot market increased. Furthermore, the system of official OPEC crude oil price (a price for the marker, Arab Light, and a differential based on quality (API gravity), sulphur and location) was the reference for trades in the spot market, sometimes the spot market leading the official prices such as during the Iranian revolution. The spot prices are actually made by information companies, first Platts and Petroleum Intelligence Weekly, which report (or at least they claim that) on actual transactions in different markets. One of the main problems of this spot market was and is that very little actual trading occurs which makes the process of price discovery very difficult. In particular, in the last few years there have been some serious doubts about the ability of the spot physical market to generate a price that reflects accurately the margin of the physical barrel of oil. However as a matter of fact (and enforced by the law of no arbitrage), the contract prices are linked to the spot prices. And any discount must be close to zero, because otherwise we could sign a long term contract and resell at the spot market.

10 Futures and Forwards: A Comparison Futures Forwards Default Risk: Borne by Clearinghouse Borne by Counter-Parties What to Trade: Standardized Negotiable The Forward/Futures Agreed on at Time Agreed on at Time Price of Trade Then, of Trade. Payment at Marked-to-Market Contract Termination Where to Trade: Standardized Negotiable When to Trade: Standardized Negotiable Liquidity Risk: Clearinghouse Makes it Cannot Exit as Easily: Easy to Exit Commitment Must Make an Entire New Contrtact How Much to Trade: Standardized Negotiable What Type to Trade: Standardized Negotiable Margin Required Collateral is negotiable Typical Holding Pd. Offset prior to delivery Delivery takes place

11 Forward Contracts:Payoff Profiles profit Long forward profit Short forward F(0,T) S(T) F(0,T) S(T) The long profits if the spot price at delivery, S(T), exceeds the original forward price, F(0,T). The short profits if the price at delivery, S(T), is below the original forward price, F(0,T). David Dubofsky and 4-11 Thomas W. Miller, Jr.

12 Oil markets - Futures Oil futures markets are not new. Price volatility in the early days of the US oil industry resulted in the first oil futures contracts in Pennsylvania in 1860s, which took the form of pipeline certificates. In 1979 heating oil became the first new futures contract at the NYMEX, and the International Petroleum Exchange (IPE) in London followed in Futures markets have grown considerably since the mid-1980s. Oil companies and traders as well as financial institutions use the futures markets for hedging against the risk of price fluctuations. At the moment, three crudes are traded on merchandise exchanges: Brent (actually, Brent, Forties, Oseberg and Ekofisk, BFOE) Western Texas Intermediate (WTI) Dubai which all have a rather marginal contribution (in particular Dubai with its dwindling output) but nevertheless serve as a marker after Saudi Arabia and OPEC stopped posting a reference price for its reference crude Arab Light. Brent, WTI and Dubai-Oman are also traded in spot markets and forward (delivery). Nearly all oil traded outside America and the Far East is priced using Brent as a benchmark. WTI is the main benchmark used for pricing oil imports into the US. Dubai- Omanis used as a benchmark for Gulf crudes (Saudi Arabia, Iran, Iraq, the UAE, Qatar and Kuwait) sold in the Asia-Pacific market.

13 Cotango vs backwardation Convenience Yield For commodities which are bought and sold for consumption, instead of as an investment into a futures contract, there are additional benefits from holding physical inventories. This additional benefit is called convenience yield. For example, inventories can smooth out the production process by filling in during shortages, or when there is higher-than-anticipated demand. Futures contracts cannot do the same. A convenience yield would reflect the difference between the costs of physical inventories and the costs of using a financial instrument.

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15 Contango vs backwardation When the convenience yield (y) is smaller than carrying costs (interests and storage fees, r + u), the market is in contango (the further out the delivery is, the more the futures price increases). When the convenience yield is larger than carrying costs, the market is in backwardation (the further out the delivery is, the more the futures price decreases). If there is a supply or demand shock with low inventories, the convenience yield is high and the market is in backwardation. Conversely, if inventories are high, the convenience yields are low and the market is in contango.

16 Cotango vs backwardation The crude market is normally in backwardation. During the period of the Gulf Crisis, crude prices were high and the market was in steep backwardation. Prices and convenience yield were falling in 1997 and most of 1998, as Asian countries were hit by economic crisis. The market went into contango. In early 1999, OPEC agreed to cut production and Norway, Mexico and Russia joined OPEC s production cut. With production cuts and a recovery from the Asian financial crisis, prices and convenience yields once again commenced upward and the market returned to backwardation. The crude market has been in contango since the beginning of ( Stay)

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21 Summary of Empirical Evidence Increase in energy price volatility in recent periods Plourde-Watkins, : oil price volatility in upper (but not outside) the range of other commodities Financial markets also exhibt an increase in volatility Contribution of liberalized markets?

22 Price fluctuations and thus volatility are an integral part of markets The fast digestion of news in markets creates volatility Tight markets induce larger price swings

23 Volatility in Oil Markets Non-OPEC Suppliers produce at capacity Price reaction function

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25 Volatility in Gas and Electricity Electricity lacks storage Decline in spare capacity

26 Electricity Spot and Futures (from Haas & Redl, 2006) [ /MWh] Jan 03 Apr 03 Jul 03 Okt 03 Jan 04 Apr 04 Jul 04 Okt 04 Jan 05 Apr 05 Jul 05 Okt 05 Jan 06 Apr 06 Jul 06 Okt 06 Spot_Base Frontjahr_Base

27 Aggregate electricity price index Quelle: E-Control

28 Electricity Spot prices Source: Haas et al. (2008) [ /MWh] IT Nordic DE FR PL ES NL CZ AT

29 NordPool 700,00 600, ,00 price [NOK/MWh] 400,00 300,00 200,00 100,00 0, week min. max. average

30 Californian Electricity Crisis

31 Carbon permit prices (ETS)

32 Prospects Volatility is here to stay (in oil, gas & electricity) Price changes reflect new informations Yet this causes adjustment costs That can hinder investment. Remedies: stocks, futures, options. Role of speculation is exaggerated in public discussions.

33 Eva Regnier (2007) Oil and anergy Prices are highly volatile And since 1970 in the top notch of 1000 commodities

34 Oil price 5-year Volatility US

35 Position of the Volatility of energy prices in the distribution in percentlies. Source: Regnier 2007.

36 Some (final) remarks Volatility (By Nassim Nicholas Taleb, Antifragile: Things that Gain from Disorder. Random House; 2012 quoted from The Economist, Nov. 17th, p76) Indeed, Mr Taleb thinks the big mistake is trying too hard to avoid shocks. Long periods of stability allow risks to accumulate until there is a major disaster; volatility means that things do not get too far out of kilter. In the economy cutting interest rates at the first sign of weakness stores up more trouble for later. In markets getting rid of speculators means prices are more stable in general but any fluctuations cause greater panic. In political systems the stability brought by regimes such as Hosni Mubarak s in Egypt was artificial; without any effective way for people to express dissent, change leads to collapse. Speculation Joseph of Egypt.