Showing papers on "Spot contract published in 2009"

Commodities and Commodity Derivatives: Modeling and Pricing for Agriculturals, Metals and Energy

Abstract: The last few years have been a watershed for the commodities, cash and derivatives industry. New regulations and products have led to an explosion in the commodities markets, creating a new asset class for investors that includes hedge funds as well as University endowments, and has resulted in a spectacular growth in spot and derivative trading. This book covers hard and soft commodities (energy, agriculture and metals) and analyses: *Economic and geopolitical issues in commodities markets *Commodity price and volume risk *Stochastic modelling of commodity spot prices and forward curves *Real options valuation and hedging of physical assets in the energy industry It is required reading for energy companies and utilities practitioners, commodity cash and derivatives traders in investment banks, the Agrifood business, Commodity Trading Advisors (CTAs) and Hedge Funds.

European Carbon Prices and Banking Restrictions: Evidence from Phase I (2005-2007)

Abstract: The price of European Union Allowances (EUAs) has been declining at far lower levels than expected during Phase I (2005-2007). Previous literature identifies among its main explanations over-allocation concerns, early abatement efforts in 2005, and possibly decreasing abatement costs in 2006. We advocate low allowance prices may also be explained by banking restrictions between 2007 and 2008, which undermined the ability of the EU ETS to provide an efficient price signal for emissions abatement. Based on a Hotelling-CAPM type analysis, our results suggest EUA spot prices do not meet equilibrium conditions in the intertemporal permits market. We also provide statistical evidence that, during the negotiation of National Allocation Plans for Phase II, the French and Polish decisions to ban banking contribute to the explanation of low EUA Phase I prices. Finally, we provide the first rigorous empirical verification that the cost-of-carry relationship between EUA spot and futures prices for delivery during Phase II does not hold after the enforcement of the inter-period banking restrictions. This situation may be interpreted as a sacrifice of the temporal flexibility offered to industrials in Phase I to give a chance to correct design inefficiencies, and achieve a price pattern leading to effective abatement efforts in Phase II.

The Impact of an increasing share of RES-E on the Conventional Power Market — The Example of Germany

Abstract: The intermittency of wind power has a decreasing effect on day-ahead spot prices. Data from Germany illustrate this effect and explain the underlying relationships. This short-term price effect leads to an adaptation process in the conventional generation capacity mix. In the long-run, a higher peak load plant share is required to cope with the increasing volatility of the residual demand. The result is an adapted merit-order. This merit-order intersects with an increasingly volatile residual demand curve and leads to a higher price volatility in the power market, which is going to trigger further adaptations. Therefore this article concludes with a list of open research questions, which can be derived from the illustrated relationship. These research questions should be investigated as soon as possible in order to induce the required adaptations in time.

Modelling spikes and pricing swing options in electricity markets

Abstract: Most electricity markets exhibit high volatilities and occasional distinctive price spikes, which result in demand for derivative products which protect the holder against high prices. In this paper we examine a simple spot price model that is the exponential of the sum of an Ornstein–Uhlenbeck and an independent mean-reverting pure jump process. We derive the moment generating function as well as various approximations to the probability density function of the logarithm of the spot price process at maturity T. Hence we are able to calibrate the model to the observed forward curve and present semi-analytic formulae for premia of path-independent options as well as approximations to call and put options on forward contracts with and without a delivery period. In order to price path-dependent options with multiple exercise rights like swing contracts a grid method is utilized which in turn uses approximations to the conditional density of the spot process.

Forecasting Model for Crude Oil Price Using Artificial Neural Networks and Commodity Futures Prices

Abstract: This paper presents a model based on multilayer feedforward neural network to forecast crude oil spot price direction in the short-term, up to three days ahead. A great deal of attention was paid on finding the optimal ANN model structure. In addition, several methods of data pre-processing were tested. Our approach is to create a benchmark based on lagged value of pre-processed spot price, then add pre-processed futures prices for 1, 2, 3,and four months to maturity, one by one and also altogether. The results on the benchmark suggest that a dynamic model of 13 lags is the optimal to forecast spot price direction for the short-term. Further, the forecast accuracy of the direction of the market was 78%, 66%, and 53% for one, two, and three days in future conclusively. For all the experiments, that include futures data as an input, the results show that on the short-term, futures prices do hold new information on the spot price direction. The results obtained will generate comprehensive understanding of the crude oil dynamic which help investors and individuals for risk managements.

A structural risk-neutral model of electricity prices

Abstract: The objective of this paper is to present a model for electricity spot prices and the corresponding forward contracts, which relies on the underlying market of fuels, thus avoiding the electricity non-storability restriction. The structural aspect of our model comes from the fact that the electricity spot prices depend on the dynamics of the electricity demand at the maturity T, and on the random available capacity of each production means. Our model explains, in a stylized fact, how the prices of different fuels together with the demand combine to produce electricity prices. This modeling methodology allows one to transfer to electricity prices the risk-neutral probabilities of the market of fuels and under the hypothesis of independence between demand and outages on one hand, and prices of fuels on the other hand, it provides a regression-type relation between electricity forward prices and forward prices of fuels. Moreover, the model produces, by nature, the well-known peaks observed on electricity market data. In our model, spikes occur when the producer has to switch from one technology to the lowest cost available one. Numerical tests performed on a very crude approximation of the French electricity market using only two fuels (gas and oil) provide an illustration of the potential interest of this model.

Linking Natural Gas Markets - Is LNG Doing its Job?

Abstract: The increase in liquefied natural gas trade has accelerated the integration of previously segmented markets in North America, Europe, and Asia. This paper provides evidence on the integration of the transatlantic natural gas market; it thus complements other papers in the EMF 23 study that focus on prices and international natural gas trade. We test the theoretical proposition that in integrating markets commodity prices should move closer than before. Using 2,059 pairs of daily spot prices for natural gas in North America and Europe we investigate price dynamics covering the period from 1999 until 2008. We apply the Kalman Filter technique which measures convergence by allowing for dynamic structural change to gain detailed information on trends inherent in prices over time. Results suggest an increasing convergence of spot prices on either side of the Atlantic Basin.

Futures Price Dynamics of CO2 Emission Certificates - An Empirical Analysis

Abstract: CO2 emission certificates are traded with increasing liquidity within the EU emissions trading scheme. Besides spot certificates, forwards and futures are also currently available OTC and on exchanges across Europe. The focus of this study is on the relationship between spot and futures markets in the EU ETS. A thorough empirical examination reveals evidence that spot and futures prices are linked by the cost-of-carry approach. After an initial period of market inefficiency, spot prices now seem to equal discounted futures prices within a trading period, which has implications for the pricing of derivative instruments on emission certificates. Moreover, we find that futures markets lead the price discovery process of CO2 emission certificates.

Motivating Retail Marketing Effort: Optimal Contract Design

Abstract: We study a distribution channel where a manufacturer relies on a sales agent for selling the product, and for investing in the most appropriate marketing effort. The agent's effort is hard to monitor. In addition, the cost of effort is the agent's private information. These impose challenges to the manufacturer in its endeavor to influence the agent's marketing effort provisions and to allocate profit between the two parties. We propose two contract forms. The franchise fee contract is a two-part price schedule specifying a variable wholesale price and a fixed franchise fee. The retail price maintenance contract links the allowed retail price that the agent charges customers with total payment to the manufacturer and sales level. Under information asymmetry, for implementing either contract form, the manufacturer needs to offer a menu of contracts, hoping to invoke the “revelation principle” when the agent picks a certain contract from that menu. We show that the two contract forms perform differently, and each party's preference toward a particular contract form is linked with the total reservation profit level and/or the sales agent's cost type. We provide managerial guidelines for the manufacturer in selecting a better contract form under different conditions.

Pricing and hedging in carbon emissions markets

Abstract: We propose a model for trading in emission allowances in the EU Emission Trading Scheme (ETS). Exploiting an arbitrage relationship we derive the spot prices of carbon allowances given a forward contract whose price is exogenous to the model. The modeling is done under the assumption of no banking of carbon allowances (which is valid during the Phase I of Kyoto protocol), however, we also discuss how the model can be extended when banking of permits is available. We employ results from filtering theory to derive the spot prices of permits and suggest hedging formulas using a local risk minimisation approach. We also consider the effect of intermediate announcements regarding the net position of the ETS zone on the prices and show that the jumps in the prices can be attributed to information release on the net position of the zone. We also provide a brief numerical simulation for the price processes of carbon allowances using our model to show the resemblance to the actual data.

Speculation and Recent Volatility in the Price of Oil

Abstract: As the price of crude oil doubled from June 2007 to June 2008, suspicion grew that price was being driven higher by speculation rather than fundamental supply and demand. After having seen the price drop 70 percent from its peak, this explanation may appear more plausible than ever. This paper introduces a new methodology that uses convenience yield – imputed from futures prices – to detect the influence of speculation on the spot price of a storable commodity. The paper finds the evidence inconsistent with speculation having played a major role in the rise of price to $100 per barrel in March 2008. However, the evidence suggests that speculation did play a role in its subsequent rise to $140. Finally, the analysis finds that the collapse in price was caused by an unanticipated decline in demand rather than by speculators unloading their positions. This implies that, absent the discovery of vast new sources of energy, high oil prices will return with the recovery of the global economy.

Cointegration between gas and power spot prices

Abstract: In this paper we show how cointegration can be applied to capture the joint dynamics of multiple energy spot prices. For an example system we study the Title Transfer Facility, the Zeebrugge gas spot market and the National Balancing Point gas spot market, and, additionally, the Amsterdam Power Exchange power spot market, since these markets are strongly connected in terms of physical transportation and generation of power from gas. We develop a cointegrating multi-market model framework that is able to plausibly connect different singlemarket spot-price models. This is achieved by considering the mean-reverting spot-forward price spreads instead of spot prices only. Our analysis shows that the gas prices are strongly cointegrated, with a specific connection pattern for the markets, whereas cointegration of gas and power prices is at long-term forward price levels only.

Forecasting Model for Crude Oil Price Using Artificial Neural Networks and Commodity Futures Prices

Abstract: This paper presents a model based on multilayer feedforward neural network to forecast crude oil spot price direction in the short-term, up to three days ahead. A great deal of attention was paid on finding the optimal ANN model structure. In addition, several methods of data pre-processing were tested. Our approach is to create a benchmark based on lagged value of pre-processed spot price, then add pre-processed futures prices for 1, 2, 3,and four months to maturity, one by one and also altogether. The results on the benchmark suggest that a dynamic model of 13 lags is the optimal to forecast spot price direction for the short-term. Further, the forecast accuracy of the direction of the market was 78%, 66%, and 53% for one, two, and three days in future conclusively. For all the experiments, that include futures data as an input, the results show that on the short-term, futures prices do hold new information on the spot price direction. The results obtained will generate comprehensive understanding of the crude oil dynamic which help investors and individuals for risk managements.

Zonal price analysis of the Italian wholesale electricity market

Abstract: In the last few years we have observed deregulation in electricity markets and an increasing interest of price dynamics has been developed especially to consider all stylized facts shown by spot prices. Only few papers, to the authors' knowledge, have considered the Italian Electricity Spot market since it has been deregulated recently. Therefore this contribution is an investigation with emphasis on prices dynamics and volatility facts taking into account extreme spiky behavior considering median and not simply mean values to correct for outliers that heavily influence the analysis. Most papers consider daily averages of spot prices as arithmetic mean of 24 hourly prices. This produces a distortion because of the existence of spikes or jumps in the price dynamics. In addition a preliminary analysis of these Italian zonal spot prices, and the resulting single national price (PUN), shows interesting features as those observed in NordPool. We aim to understand price and volatility dynamics for production planning, pricing and risk-hedging problems proposing Reg-ARFIMA models considering at the same time congestions and technologies. Hence we provide evidence that all zonal prices and standard deviations are fractionally integrated and congestion costs, as defined in [7], play an important role in both studied dynamics. Finally, we draw policy indications regarding investment strategies in new power plant generators and in reinforced grid interconnections.

VaR constrained hedging of fixed price load-following obligations in competitive electricity markets

Abstract: Load serving entities providing electricity to regulated customers have an obligation to serve load that is subject to systematic and random fluctuations at fixed prices. In some jurisdictions like New Jersey, such obligations are auctioned off annually to third parties that commit to serve a fixed percentage of the fluctuating load at a fixed energy price. In either case the entity holding the load following obligation is exposed to the load variation and to a volatile wholesale spot market price which is correlated with the load level. Such double exposure to price and volume results in a net revenue exposure that is quadratic in price and cannot be adequately hedged with simple forward contracts whose payoff is linear in price. A fixed quantity forward contract cover, is likely to be short when the spot price is high and long when the spot price is low. In this paper we develop a self-financed hedging portfolio consisting of a risk free bond, a forward contract and a spectrum of call and put options with different strike prices. A popular portfolio design criterion is the maximization of expected hedged profits subject to a value at risk (VaR) constraint. Unfortunately, that criteria is difficult to implement directly due to the complicated form of the VaR constraint. We show, however, that under plausible distributional assumptions, the optimal VaR constrained portfolio is on the efficient mean-variance frontier. Hence, we propose an approximation method that restricts the search for the optimal VaR constrained portfolio to that efficient frontier. The proposed approach is particularly attractive when the mean-variance efficient frontier can be represented analytically, as is the case, when the load and logarithm of price follow a bivariate normal distribution. We illustrate the results with a numerical example.

Modelling Electricity Prices with Forward Looking Capacity Constraints

Abstract: We present a spot price model for wholesale electricity prices which incorporates forward looking information that is available to all market players. We focus on information that measures the extent to which the capacity of the England and Wales generation park will be constrained over the next 52 weeks. We propose a measure of ‘tight market conditions’, based on capacity constraints, which identifies the weeks of the year when price spikes are more likely to occur. We show that the incorporation of this type of forward looking information, not uncommon in electricity markets, improves the modelling of spikes (timing and magnitude) and the different speeds of mean reversion.

Designing a U.S. Market for CO2

Abstract: The United States may soon have a market for carbon. If so, that market will grow out of a cap-and-trade system like the EU's Emissions Trading System for CO2 or the U.S. Acid Rain Program for SO2. This article reviews the historical performance of these two markets, with particular focus on how the flexibility afforded by, as well as restrictions on, the “banking” and borrowing of allowances has affected the evolution of prices. While both markets have generally functioned well, four episodes are used to illustrate the importance of designing the rules to encourage such flexibility. The 2005 opening of the EU CO2 market was marked by a surprisingly high price, one that resulted from a delay in institutions with long positions in allowances (“longs”) bringing supply to the market. The 2007 close of the first phase produced a sharp divergence between the spot price at the end of 2007 and the futures price for 2008, reflecting the restriction against carrying over (or “banking”) allowances from one phase to the next. The U.S. SO2 market's transition to a tighter system in 2000 avoided such a divergence by allowing unlimited banking of allowances into the second phase. In 2005-2006, the U.S. SO2 market experienced a surprising price spike attributable to a combination of changing fundamentals and institutional features (notably, the tax treatment of “longs”) that undermined the flexibility of the bank.

Do daily retail gasoline prices adjust asymmetrically

Abstract: This paper analyzes adjustments in the Dutch retail gasoline prices. We estimate an error correction model on changes in the daily retail price for gasoline (taxes excluded) for the period 1996-2004 taking care of volatility clustering by estimating an EGARCH model. It turns out the volatility process is asymmetrical: an unexpected increase in the producer price has a larger eect on the variance of the producer price than an unexpected decrease. We do not nd evidence for amount asymmetry, either for the long run or for the short run. However, there is a faster reaction to upward changes in spot prices than to downward changes in spot prices. This implies timing or pattern asymmetry. This asymmetry starts three days after the change in the spot price and lasts for four days.

Equilibrium pricing of contingent claims in tradable permit markets

Abstract: We advance a model of the tradable permit market and derive a pricing formula for contingent claims traded in the market in a general equilibrium framework. It is shown that prices of such contingent claims exhibit significantly different properties from those in the ordinary financial markets. In particular, if the social cost function kinks at some level of abatement, the forward price, as well as the spot price, can be subject to the so-called price spike. However, this price-spike phenomenon can be weakened if a system of banking and borrowing is properly introduced. © 2009 Wiley Periodicals, Inc. Jrl Fut Mark 30:559–589, 2010

Forward and futures prices with bubbles

Abstract: This paper extends and refines the Jarrow et al. (2006, 2008) arbitrage free pricing theory for bubbles to characterize forward and futures prices. Some new insights are obtained in this regard. In particular, we: (i) provide a canonical process for asset price bubbles suitable for empirical estimation, (ii) discuss new methods to test empirically for asset price bubbles using both spot prices and call/put option prices on the spot commodity, (iii) show that futures prices can have bubbles independent of the underlying asset's price bubble, (iv) relate forward and futures prices under bubbles, and (v) relate price options on futures with asset price bubbles.