Natural gas and petroleum products are the second most heavily traded category of futures contracts on organized exchanges, after financial products, according to a new Energy Information Administration (EIA) report released last month. The government agency noted that the growth in derivatives — i.e., futures, options, swaps and forwards — points out just how volatile energy markets are.

In its report: Derivatives and Risk Management in the Petroleum, Natural Gas, and Electricity Industries, EIA said the daily average volume of energy-related futures contracts on the New York Mercantile Exchange (Nymex) grew from approximately 7,340 in 1982 to 467,042 in the first half of 2002. “Essentially all of these contracts involve natural gas and petroleum,” EIA said.

The EIA report found that over the past decade, natural gas prices have been five times more volatile than the Standard and Poor’s 500 (S&P 500) stock index. Gasoline and heating oil have been about two-and-a-half times more volatile, while wholesale electricity prices in the East and West have been 20 times more volatile than the S&P 500 over the past five years.

With rapidly changing, volatile prices becoming prevalent, domestic energy industries have turned to derivatives in an attempt to manage them effectively.

“Energy companies have increasingly purchased and sold futures contracts, options, swaps and other derivatives to lock in favorable prices,” the EIA said in its report. “By transferring price risk to those more able and willing to bear it, firms smooth out their cash needs and can invest in worthwhile projects they otherwise would forgo.”

Despite the boom of derivative use in the oil and gas markets, EIA found that derivatives in electricity markets have not met with a great deal of success. Nymex began offering electricity derivatives in March 1996, and the Chicago Board of Trade and the Minneapolis Grain Exchange have also offered electricity derivatives according to the EIA.

The agency pointed out that although Nymex had the most success — at one point listing six different futures contracts — with electric derivatives, there are currently no electricity contracts listed on the regulated exchanges. Trading in electricity futures and options contracts peaked in the Fall of 1998, but by the Fall of 2000 most activity had ceased.

“The prospects for the growth of an active electricity derivatives market are tied to the success of the Federal Energy Regulatory Commission’s (FERC’s) recent initiatives to build a competitive electricity market,” EIA said. “A well-functioning electricity market would encourage the revival of electricity derivative markets and provide the industry with powerful tools to manage price risk.”

The 106-page report in its entirety can be found on EIA’s web site at: https://tonto.eia.doe.gov/FTPROOT/service/smg2002-01.pdf.

©Copyright 2003 Intelligence Press Inc. All rights reserved. The preceding news report may not be republished or redistributed, in whole or in part, in any form, without prior written consent of Intelligence Press, Inc.