The ABCs of Energy Hedging
Crude oil and petroleum products are traded globally 24 hours a day, every business day in both the physical and paper markets. With the daily physical consumption of oil of almost 80 million barrels and annual trade valued at over $1 trillion, the growth in paper energy trading seems assured, with new financial products evolving to meet the needs of producers, refiners, marketers, and consumers. Paper trading for oil has grown on established futures exchanges to almost 400 million bbl/d with much greater growth on the OTC markets. Moreover, because major oil companies must now buy and trade on the spot markets to meet more of their supply needs that were previously met by their own production, their active involvement in paper trading has increased over time. These changes, coupled with periods of supply-tightness and higher prices since late 1998 and the current oversupply and lower prices, have led to greater oil price volatility, and show that energy price risk management must be increasingly managed by a wide variety of existing and emerging financial instruments for the longer term.
KeywordsCredit Risk Price Volatility Future Contract Market Maker Physical Market
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