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UK gas markets: The market price of risk and applications to multiple interruptible supply contracts

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  • Cartea, Álvaro
  • Williams, Thomas

Abstract

We employ the Schwartz and Smith [Schwartz, E., and J. Smith, 2000, Short-term variations and long-term dynamics in commodity prices, Management Science 46, 893-911.] model to explore the dynamics of the UK gas markets. We discuss in detail the short-term and long-term market prices of risk borne by the market players and how deviations from expected cyclical storage affect the short-term market price of risk. Finally, we illustrate an application of the model by pricing interruptible supply contracts that are currently traded in the UK.

Suggested Citation

  • Cartea, Álvaro & Williams, Thomas, 2008. "UK gas markets: The market price of risk and applications to multiple interruptible supply contracts," Energy Economics, Elsevier, vol. 30(3), pages 829-846, May.
  • Handle: RePEc:eee:eneeco:v:30:y:2008:i:3:p:829-846
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    1. repec:eee:eneeco:v:64:y:2017:i:c:p:415-437 is not listed on IDEAS
    2. Cartea, Álvaro & González-Pedraz, Carlos, 2012. "How much should we pay for interconnecting electricity markets? A real options approach," Energy Economics, Elsevier, pages 14-30.
    3. Füss, Roland & Mahringer, Steffen & Prokopczuk, Marcel, 2015. "Electricity derivatives pricing with forward-looking information," Journal of Economic Dynamics and Control, Elsevier, vol. 58(C), pages 34-57.
    4. van Goor, Harm & Scholtens, Bert, 2014. "Modeling natural gas price volatility: The case of the UK gas market," Energy, Elsevier, vol. 72(C), pages 126-134.
    5. Hulshof, Daan & van der Maat, Jan-Pieter & Mulder, Machiel, 2016. "Market fundamentals, competition and natural-gas prices," Energy Policy, Elsevier, vol. 94(C), pages 480-491.
    6. Gr'egory Benmenzer & Emmanuel Gobet & C'eline J'erusalem, 2007. "Arbitrage free cointegrated models in gas and oil future markets," Papers 0712.3537, arXiv.org.
    7. Reik H. Boerger & Alvaro Cartea & Ruediger Kiesel & Gero Schindlmayr, 2007. "A Multivariate Commodity Analysis and Applications to Risk Management," Birkbeck Working Papers in Economics and Finance 0709, Birkbeck, Department of Economics, Mathematics & Statistics.
    8. Abadie, Luis M. & Chamorro, José M., 2008. "Valuing flexibility: The case of an Integrated Gasification Combined Cycle power plant," Energy Economics, Elsevier, vol. 30(4), pages 1850-1881, July.
    9. Arismendi, Juan C. & Back, Janis & Prokopczuk, Marcel & Paschke, Raphael & Rudolf, Markus, 2016. "Seasonal Stochastic Volatility: Implications for the pricing of commodity options," Journal of Banking & Finance, Elsevier, vol. 66(C), pages 53-65.
    10. repec:kap:rqfnac:v:48:y:2017:i:3:d:10.1007_s11156-016-0569-x is not listed on IDEAS
    11. Fusai, Gianluca & Marena, Marina & Roncoroni, Andrea, 2008. "Analytical pricing of discretely monitored Asian-style options: Theory and application to commodity markets," Journal of Banking & Finance, Elsevier, vol. 32(10), pages 2033-2045, October.
    12. Füss, Roland & Mahringer, Steffen & Prokopczuk, Marcel, 2013. "Electricity Spot and Derivatives Pricing when Markets are Interconnected," Working Papers on Finance 1323, University of St. Gallen, School of Finance.
    13. Shao, Chengwu & Bhar, Ramaprasad & Colwell, David B., 2015. "A multi-factor model with time-varying and seasonal risk premiums for the natural gas market," Energy Economics, Elsevier, pages 207-214.
    14. Mihaela NICOLAU & Giulio PALOMBA & Ilaria TRAINI, 2013. "Are Futures Prices Influenced by Spot;Prices or Vice-versa? An Analysis of Crude;Oil, Natural Gas and Gold Markets," Working Papers 394, Universita' Politecnica delle Marche (I), Dipartimento di Scienze Economiche e Sociali.
    15. Hobæk Haff, Ingrid & Lindqvist, Ola & Løland, Anders, 2008. "Risk premium in the UK natural gas forward market," Energy Economics, Elsevier, vol. 30(5), pages 2420-2440, September.
    16. Bisht Deepak & Laha, A. K., 2017. "Assessment of Density Forecast for Energy Commodities in Post-Financialization Era," IIMA Working Papers WP 2017-07-01, Indian Institute of Management Ahmedabad, Research and Publication Department.
    17. repec:gam:jrisks:v:5:y:2017:i:3:p:48-:d:111674 is not listed on IDEAS
    18. Abadie, Luis M. & Chamorro, José M., 2009. "Monte Carlo valuation of natural gas investments," Review of Financial Economics, Elsevier, pages 10-22.
    19. Heydari, Somayeh & Siddiqui, Afzal, 2010. "Valuing a gas-fired power plant: A comparison of ordinary linear models, regime-switching approaches, and models with stochastic volatility," Energy Economics, Elsevier, vol. 32(3), pages 709-725, May.
    20. Benth, Fred Espen & Cartea, Álvaro & Kiesel, Rüdiger, 2008. "Pricing forward contracts in power markets by the certainty equivalence principle: Explaining the sign of the market risk premium," Journal of Banking & Finance, Elsevier, vol. 32(10), pages 2006-2021, October.
    21. Nicole Bauerle & Viola Riess, 2014. "Gas Storage valuation with regime switching," Papers 1412.1298, arXiv.org.

    More about this item

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis

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