1932
0
  1. Home
  2. A-Z Publications
  3. Annual Review of Financial Economics
  4. Volume 9, 2017
  5. Article

Annual Review of Financial Economics

Volume 9, 2017

The Fundamentals Underlying Oil and Natural Gas Derivative Markets

Abstract

What determines the range and boundaries of energy derivative markets? Why is the oil futures trade dominated by contracts on two grades and locations when the global trade encompasses many grades and locations? Should we expect change in the near future? We review research on the establishment and performance of energy derivative markets, focusing on the two major energy commodities: oil and natural gas. For both commodities, trade in derivatives arose at the conclusion of a historical process in which production along the value chain that had been coordinated by vertically integrated companies or similar institutional structures switched to being coordinated through markets. Consequently, much of the research reviewed here is about the structural changes that made it possible for markets to assume this role. This review encompasses research into the price discovery function, which determines how many successful futures contracts are needed for each commodity.

Keyword(s): commodity derivatives, commodity futures, industry structure, price discovery
Loading

Article metrics loading...

/content/journals/10.1146/annurev-financial-110716-032610
2017-11-01
2024-04-27
Loading full text...

Full text loading...

/deliver/fulltext/financial/9/1/annurev-financial-110716-032610.html?itemId=/content/journals/10.1146/annurev-financial-110716-032610&mimeType=html&fmt=ahah

Literature Cited

  1. Acharya VV, Lochstoer LA, Ramadorai T. 2013. Limits to arbitrage and hedging: evidence from commodity markets. J. Financ. Econ. 109:2441–65 [Google Scholar]
  2. Adelman MA. 1972. World Petroleum Market Baltimore, MD: Johns Hopkins Univ. . Press
  3. Adelman MA. 1984. International oil agreements. Energy J. 5:31–9 [Google Scholar]
  4. Atkinson FJ, Brooks SJ, Hall SGF. 1983. The economic effects of North Sea oil. Natl. Inst. Econ. Rev.38–44
  5. Bekiros S, Diks C. 2008. The relationship between crude oil spot and futures prices: cointegration, linear and nonlinear causality. Energy Econ. 30:2673–85 [Google Scholar]
  6. Bentzen J. 2007. Does OPEC influence crude oil prices? Testing for co-movements and causality between regional crude oil prices. Appl. Econ. 39:111375–85 [Google Scholar]
  7. Bossley L. 1999. Trading Natural Gas in the UK Oxford, UK: Oxford Inst. Energy Stud.
  8. BP (Br. Pet.) 2016. BP Statistical Review of World Energy, June 2016 London: BP
  9. Brennan MJ. 1958. The supply of storage. Am. Econ. Rev. 48:150–72 [Google Scholar]
  10. Brinkmann EJ, Rabinovitch R. 1995. Regional limitations on the hedging effectiveness of natural gas futures. Energy J. 16:3113–24 [Google Scholar]
  11. Brown S, Yücel M. 2009. Market arbitrage: European and North American natural gas prices. Energy J. 30:Special Issue167–85 [Google Scholar]
  12. Buyuksahin B, Lee TK, Moser JT, Robe MA. 2013. Physical markets, paper markets and the WTI–Brent spread. Energy J. 34:3129–52 [Google Scholar]
  13. Carlson M, Khokher Z, Titman S. 2007. Equilibrium exhaustible resource price dynamics. J. Finance 62:41663–703 [Google Scholar]
  14. Cheng IH, Xiong W. 2014. Financialization of commodity markets. Annu. Rev. Financ. Econ. 6:1419–41 [Google Scholar]
  15. Cortazar G, Schwartz ES. 2003. Implementing a stochastic model for oil futures prices. Energy Econ. 25:3215–38 [Google Scholar]
  16. Dai YH, Xie WJ, Jiang ZQ, Jiang GJ, Zhou WX. 2015. Correlation structure and principal components in the global crude oil market. Empir. Econ. 51:41501–19 [Google Scholar]
  17. Dale C. 1991. Economics of energy futures markets MPRA Pap. 47447
  18. De Vany AS, Walls WD. 1994. Open access and the emergence of a competitive natural gas market. Contemp. Econ. Policy 12:277–96 [Google Scholar]
  19. Doane MJ, Spulber DF. 1994. Open access and the evolution of the US spot market for natural gas. J. Law Econ. 37:2477–517 [Google Scholar]
  20. Dominguez KM. 1989. The volatility and efficiency of crude oil futures contracts. Oil and Money: Coping with Price Risk Through Financial Markets KM Dominguez, JS Strong, RJ Weiner 48–97 Cambridge, MA: Energy Environ. Policy Cent.
  21. Dvir E, Rogoff KS. 2009. Three epochs of oil NBER Work. Pap. 14927
  22. EIA (Energy Inf. Admin.) 2002. Derivatives and Risk Management in the Petroleum, Natural Gas, and Electricity Industries Washington, DC: EIA
  23. Elder J, Miao H, Ramchander S. 2014. Price discovery in crude oil futures. Energy Econ. 46:S18–27 [Google Scholar]
  24. Fattouh B. 2010. The dynamics of crude oil price differentials. Energy Econ. 32:2334–42 [Google Scholar]
  25. FERC (Fed. Energy Regul. Commis.) 2003. Final report on price manipulation in Western markets: fact-finding investigation of potential manipulation of electric and natural gas prices. Docket PA02-2-000, FERC, Washington, DC
  26. Gilje E, Taillard J. 2016. Does hedging affect firm value? Evidence from a natural experiment Work. Pap., Wharton Sch., Univ. Pa.
  27. Gorton GB, Hayashi F, Rouwenhorst KG. 2013. The fundamentals of commodity futures returns. Rev. Finance 17:135–105 [Google Scholar]
  28. Hasbrouck J. 1995. One security, many markets: determining the contributions to price discovery. J. Finance 50:41175–99 [Google Scholar]
  29. Heather P. 2010. The evolution and functioning of the traded gas market in Britain Work. Pap. NG 44, Oxford Inst. Energy Stud Univ. Oxford:
  30. Heather P. 2012. Continental European gas hubs: Are they fit for purpose? Work. Pap. NG 63, Oxford Inst. Energy Stud Univ. Oxford:
  31. IEA (Int. Energy Agency) 2013. Developing a Natural Gas Trading Hub in Asia: Obstacles and Opportunities Paris: IEA
  32. Joskow PL. 2013. Natural gas: from shortages to abundance in the United States. Am. Econ. Rev. 103:3338–43 [Google Scholar]
  33. Juris A. 1998. Natural gas markets in the UK: competition, industry structure, and market power of the incumbent Note 138 World Bank Washington, DC:
  34. Kaldor N. 1939. Speculation and economic stability. Rev. Econ. Stud. 7:11–27 [Google Scholar]
  35. Kao CW, Wan JY. 2009. Information transmission and market interactions across the Atlantic—an empirical study on the natural gas market. Energy Econ. 31:1152–61 [Google Scholar]
  36. Kao CW, Wan JY. 2012. Price discount, inventories and the distortion of WTI benchmark. Energy Econ. 34:1117–24 [Google Scholar]
  37. Kaufmann RK, Ullman B. 2009. Oil prices, speculation, and fundamentals: interpreting causal relations among spot and futures prices. Energy Econ. 31:4550–58 [Google Scholar]
  38. Keynes JM. 1930. Treatise on Money London: Macmillan
  39. Kleit AN, Lo Prete C, Blumsack S, Guo N. 2015. Weather or not? Welfare impacts of natural gas pipeline expansion in the northeastern US Work. Pap., Pa. State Univ.
  40. Kogan L, Livdan D, Yaron A. 2009. Oil futures prices in a production economy with investment constraints. J. Finance 64:31345–75 [Google Scholar]
  41. Leach B. 2016. Natural gas hub development and the Asian LNG market Presented at IAEE Asian Conf., 5th, Feb. 15, Perth, Aust.
  42. Li R, Joyeux R, Ripple RD. 2014. International natural gas market integration. Energy J. 35:4159–79 [Google Scholar]
  43. Litzenberger RH, Rabinowitz N. 1995. Backwardation in oil futures markets: theory and empirical evidence. J. Finance 50:51517–45 [Google Scholar]
  44. Liu WM, Schultz E, Swieringa J. 2015. Price dynamics in global crude oil markets. J. Futures Markets 35:2148–62 [Google Scholar]
  45. MacAvoy PW. 2000. The Natural Gas Market: Sixty Years of Regulation and Deregulation New Haven, CT: Yale Univ. Press
  46. Marmer V, Shapiro D, MacAvoy P. 2007. Bottlenecks in regional markets for natural gas transmission services. Energy Econ. 29:37–45 [Google Scholar]
  47. McDaniel T, Neuhoff K. 2004. Auctions of gas transmission access: the British experience. Auctioning Public Assets: Analysis and Alternatives MCW Janssen 197–229 Cambridge, UK: Cambridge Univ. Press [Google Scholar]
  48. Mixon S, Onur E, Riggs L. 2016. Exploring commodity trading activity: an integrated analysis of swaps and futures Presented at NCCC-134 Conf. Appl. Commod. Price Anal. Forecast. Market Risk Manag., April 18–19, St. Louis, MO
  49. Mohnfeld JH. 1984. The trend of structural change in the international oil industry in the 1980s. Annu. Rev. Energy 9:1155–77 [Google Scholar]
  50. Neumann A. 2009. Linking natural gas markets: Is LNG doing its job. Energy J. 30:187–99 [Google Scholar]
  51. Nicolau M, Palomba G, Traini I. 2013. Are futures prices influenced by spot prices or vice-versa? An analysis of crude oil, natural gas and gold markets Work. Pap. 394, Dip. Sci. Econ. Soc., Univ. Politec. Marche
  52. Paltsev S, Zhang D. 2015. Natural gas pricing reform in China: getting closer to a market system. Energy Policy 86:43–56 [Google Scholar]
  53. Parsons JE. 1989. Estimating the strategic value of long-term forward purchase contracts using auction models. J. Finance 44:4981–1010 [Google Scholar]
  54. Parsons JE. 2013a. Do trading and power operations mix. J. Appl. Corp. Finance 25:430–36 [Google Scholar]
  55. Parsons JE. 2013b. Mapping and measuring the channels of oil price exposure in the economy and the role of oil derivatives in reshaping them Work. Pap. 2013-013, Cent. Energy Environ. Policy Res., MIT
  56. Price CW. 2005. The effect of liberalizing UK retail energy markets on consumers. Oxford Rev. Econ. Policy 21:1128–44 [Google Scholar]
  57. Ritz RA. 2014. Price discrimination and limits to arbitrage: an analysis of global LNG markets. Energy Econ. 45:324–32 [Google Scholar]
  58. Routledge BR, Seppi DJ, Spatt CS. 2000. Equilibrium forward curves for commodities. J. Finance 55:31297–338 [Google Scholar]
  59. Rouwenhorst K, Tang K. 2012. Commodity investing. Annu. Rev. Financ. Econ. 4:1447–67 [Google Scholar]
  60. Schultz E, Swieringa J. 2013. Price discovery in European natural gas markets. Energy Policy 61:628–34 [Google Scholar]
  61. Schwartz E, Smith JE. 2000. Short-term variations and long-term dynamics in commodity prices. Manag. Sci. 46:7893–911 [Google Scholar]
  62. Schwarz TV, Szakmary AC. 1994. Price discovery in petroleum markets: arbitrage, cointegration, and the time interval of analysis. J. Futures Markets 14:2147–67 [Google Scholar]
  63. Shi X, Variam HMP. 2015. China's gas market liberalisation: the impact on China–Australia gas trade. China's Domestic Transition in a Global Context L Song, R Garnaut, C Fang, L Johnston 137–74 Acton, Aust.: ANU Press [Google Scholar]
  64. Shi X, Variam HMP. 2016. Gas and LNG trading hubs, hub indexation and destination flexibility in East Asia. Energy Policy 96:587–96 [Google Scholar]
  65. Shrestha K. 2014. Price discovery in energy markets. Energy Econ. 45:229–33 [Google Scholar]
  66. Simkins B, Jia Y. 2016. Energy futures markets. The World Scientific Handbook of Futures Markets AG Malliaris, WT Ziemba 407–34 Singapore: World Sci. [Google Scholar]
  67. Stern J. 2014. International gas pricing in Europe and Asia: a crisis of fundamentals. Energy Policy 64:43–48 [Google Scholar]
  68. Tang K, Zhu H. 2016. Commodities as collateral. Rev. Financ. Stud. 29:2110–60 [Google Scholar]
  69. Telser LG. 1958. Futures trading and the storage of cotton and wheat. J. Political Econ. 66:3233–55 [Google Scholar]
  70. Verleger PK. 1987. The evolution of oil as a commodity. Energy: Markets and Regulation RL Gordon, HD Jacoby, MB Zimmerman 161–86 Cambridge, MA: MIT Press [Google Scholar]
  71. Verleger PK. 1988. The role and impact of commodity market institutions in the determination of oil prices. Annu. Rev. Energy 13:1359–82 [Google Scholar]
  72. Weiner RJ. 1989. The WTI futures market and the Brent forward market: a comparative analysis. Oil and Money: Coping with Price Risk Through Financial Markets KM Dominguez, JS Strong, RJ Weiner 7–47 Cambridge, MA: Energy Environ. Policy Cent. [Google Scholar]
  73. Weiner RJ. 1991. Is the world oil market “one great pool”?. Energy J. 12:95–107 [Google Scholar]
  74. Weiner RJ. 2003. Financial innovation in an emerging market: petroleum derivatives trading in the 19th century Work. Pap. 98-64, Sch. Bus. Public Manag George Washington Univ.:
  75. Williams JC, Wright BD. 1991. Storage and Commodity Markets Cambridge, UK: Cambridge Univ. Press
  76. Working H. 1949. The theory of price of storage. Am. Econ. Rev. 39:61254–62 [Google Scholar]
  77. Yergin D. 1991. The Prize: The Epic Quest for Oil, Money, and Power New York: Simon & Schuster
/content/journals/10.1146/annurev-financial-110716-032610
Loading
The Fundamentals Underlying Oil and Natural Gas Derivative Markets
Annual Review of Financial Economics 9, 283 (2017); https://doi.org/10.1146/annurev-financial-110716-032610
/content/journals/10.1146/annurev-financial-110716-032610
/content/journals/10.1146/annurev-financial-110716-032610
Loading

Data & Media loading...

  • Article Type: Review Article

Most Cited Most Cited RSS feed

This is a required field
Please enter a valid email address
Approval was a Success
Invalid data
An Error Occurred
Approval was partially successful, following selected items could not be processed due to error