Energy Derivatives Pricing, Hedging and Risk Management

Energy Derivatives Pricing, Hedging and Risk Management (DPH2) builds on the concepts and instruments presented in Energy Derivatives Markets, Instruments and Hedging (DPH1) and provides an overview of Energy derivatives Pricing and Risk Management.

We will start with a review of Energy Price Behavior, Probability and Statistics and various Excel exercises with hands-on calculations of various risk statistics. As a review and extension of some of the structures presented in DPH1, a common framework to analyze derivatives structures and long term contracts is also presented.

The course also covers an introduction to derivatives pricing models and relevant accounting rules such as FAS 157. Implied volatility and "Greeks" are presented using practical exercises. The course also covers analysis of structured products used by producers and end-users such as extendable swaps; spot price models, geometric brownian motion and mean-reverting models for pricing and risk analysis; market risk with particular emphasis on VaR; basis risk and derivatives in energy markets with an overview of hedge effectiveness under FAS 133. The course concludes with an overview of stress testing for energy derivatives portfolios.

Please note: a laptop and up-to-date version of Excel software is required in order to engage in market data.

8 CPE credits per training day awarded for this course.

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• Market risk managers
• Energy traders
• Trading managers
• End-users of derivatives in corporations
• Credit risk analysts
• Risk consultants
• Risk and audit committee members
• CFOs and treasury managers
• Finance department personnel
• Compliance managers
• Middle and back-office personnel
• Treasurers and treasury analysts
• Chief risk officers

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Review of Energy Price Behavior, Probability and Statistics

• Overview of energy price behavior; seasonality; mean reversion; spikes
• Spot vs. forward prices; price indices and market liquidity
• Building forward curves in illiquid energy markets
• Volatility structure in energy markets; spot vs. forwards
• Probability distributions; moments of a distribution.
• Calculating volatility and correlation.
• Excel exercises with hands-on calculations of various risk statistics

Energy Derivatives Structures

• How to unbundle embedded risk structures in energy contracts
• Building blocks: long vs. short; option types; volumes; strike price; exercise style; underlying; trigger event/contingency; payoff type
• Review of main derivatives structures: futures and forwards; fixed for floating and basis swaps; European and American options; basis swaps and options; exotic options
• Overview of swing contracts

Mark-to-Market vs. Mark-to-Model: Introduction to Derivatives Pricing Models: Conceptual Interpretation. Uses. Pros and Cons

• Mark-to-market vs. mark-to-model. Conceptual interpretation.
• Overview of FAS 157 and three "fair value" levels. Adding the liquidity dimension Closed-form solutions (formulas). Case study: Pricing an option using Black 76 in Excel.
• Monte Carlo simulation based models. Case study: Generating random paths in Excel.
• Binomial and trinomial trees. Case study: Pricing an American option.
• Understanding option sensitivities through the "Greeks" Case study: calculating and visualizing "Greeks" in Excel

Analysis of Derivative Strategies

• Zero-cost collars
• Three-way collars
• Bull and bear spreads
• Volatility plays: straddles and strangles
• Exotic swaps: extendable, cancelable, double-up swaps

Energy Price Behaviour: Overview of spot price models

• Spot price models for energy and commodity markets
• Understanding price processes; parameterization
• Geometric Brownian motion; uses and limitations
• Mean reversion; limit of variance ("terminal distribution"). Case study: Simulating a mean-reverting process in Excel.
• Jump diffusion and mean reverting with jumps price processes

Market Risk Management for Energy Trading

• Market risk and "risk factors"
• Understanding VaR and expected tail loss (ETL)
• Overview of methodologies: analytic, Monte Carlo and historical simulation
• Case study: interpretation of market risk disclosures for large energy firm
• Oil, power, coal and gas specific issues
• Case study: calculating VaR in a spreadsheet

Basis Risk and Derivatives in Energy Markets

• Understanding correlation. Seasonality considerations.
• FAS 133 and hedge effectiveness. ex-ante vs. ex-post tests
• Case study: Hedging strategy by airlines
• Minimum variance ratio using volatility and correlation analysis
• Correlations between spot and forward contracts
• Pitfalls of correlation as a measure of dependence
• Case study: natural gas location basis risk

Stress Testing and Backtesting for Energy and Commodity Firms

• Designing and conducting stress tests
• Benefits of stress tests
• Standard & Poors liquidity risk survey and stress testing
• Integrating stress tests in the risk modeling process
• Stress tests for crude and products; gas; electricity
• Exercise: Stress tests and technical risk reviews

Faculty

DR CARLOS BLANCO is an expert in energy, commodity, and financial risk management and modeling. He has been a faculty member of the Oxford Princeton Programme since 2004, where he teaches the Derivatives Pricing Hedging and Risk Management Certificate Programme as well as courses on Counterparty Risk Management and Gas and Power Trading and Risk Management.

Testimonials

If you have attended a past course please provide us with some feedback.

“The instructor was extremely knowledgeable and the materials/tools will be useful for years to come in my organization!” S.H., Imperial Irrigation