Energy Markets: The Instruments

Vincent Kaminski

This chapter will provide a review of the different instruments that can be used by energy markets participants to market or trade different energy commodities, hedge their exposures related to energy prices, or to make directional bets on market directions. The objective is to concentrate on common features shared by the various instruments, irrespective of differences with respect to underlying physical commodities. The review of such instruments is necessary in order to follow the discussions of different markets contained in subsequent chapters. The instruments covered here include forwards and futures, swaps and options. More complex types of transactions will be covered in the next chapter.

Understanding derivative instruments is a critical skill that any participant in the energy markets requires. Energy-related transactions are saturated with options: any contractual flexibility with respect to delivery timing and location, quality of the underlying commodity, volume, ability to discontinue or restart production, can be translated into some type of a derivative. These derivatives tend to interact and overlap, and are contingent on each other and on non