Managing Energy Price Risk with Derivatives

September 18, 2003 - 12:00pm
Bldg. 90
Seminar Host/Point of Contact: 

Energy derivatives came into being with the deregulation of the petroleum and natural gas industries in the early 1980s. Although derivatives-forwards, futures and options-have been used in American agriculture since the mid-1800's to manage price risk, they were unnecessary in regulated energy industries. Deregulation revealed that oil, gas and electricity prices are exceptionally volatile. Companies were forced to cope with the uncertainty in energy prices; they latched onto derivatives as one tool for managing that risk. Enron's collapse brought energy derivatives to public attention. Following the derivative linked failures of the Orange County Investment Pool (Pension Fund) in 1990, MG Corporation (Metallgesellschaft) in 1993, the Barings Bank in 1995 and the near failure of Long Term Capital Management 1998-1999, derivatives have been derided as little more than legalized gambling with the public picking up the tab. This talk describes how derivatives have been used to manage energy price risk. And it indicates why derivatives are still a mainstay of energy price risk management.  It also describes how swaps, a newer type of derivative, were misused by Enron to hide debt and to assume huge financial liabilities. The talk is intended to take some of the mystery out of these exotic financial instruments.

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