The energy glossary: the most comprehensive reference source for anyone involved in the global energy markets

Glossary 2011

Published by energy risk MANAGEMENT & TRADING

Introduction

H The Energy Risk glossary, now in its 7th and the Volcker Rule appearing for the first edition, provides an at-a-glance explanation of time. There are two new entries and an the many specialised terms and acronyms used update pertaining to hydropower, reflecting in energy trading and . the increasing role of renewables in electric This year, the guide has been updated power generation. by former director of enforcement at the The glossary is extensively cross-referenced, Commodity Futures Trading Commission, making for easy and thorough searches. We Gregory Mocek, now head of the Energy hope you find it a valuable reference tool in the and Commodities Enforcement Defense months to come. n team at Cadwalader, Wickersham & Taft, and Benjamin Chesson, associate at the firm. Energy Risk would like to thank them both for their input into this edition, which benefits greatly from their experience and insight into Stella Farrington energy markets. Editor, Energy Risk Almost 100 new entries and revisions have been made this year. Some of these reflect the increasing role of regulation on the , with terms such as the Lincoln Amendment

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As a market leader, E.ON Energy Trading optimises and manages commodity risk for Europe’s broadest and most diverse power and gas asset base, and is committed to supporting the development of more open, competitive energy markets Experts at the heart of global energy markets

* E.ON Energy Trading SE is the energy 650 million tonnes of CO2 certificates, Managing risk, optimising assets approach requires extensive cross-market trading business of E.ON, one of the world’s 290 million tonnes of coal and more than Our primary responsibilities are to manage and cross-commodity expertise, as well as largest power and gas companies. As the 500 million barrels of oil in 2010. the E.ON Group’s commodity price , a forecasting ability that factors in national, expert interface between E.ON and the including commercial portfolios, and European and global price trends. international wholesale energy markets, we A single, integrated view of to optimise E.ON’s power and gas asset buy and sell electricity, natural gas, oil, coal, wholesale energy markets base. Within clearly defined limits, and in Supporting the development of biomass, freight and emissions certificates. Three years ago, E.ON united its trading accordance with the highest standards of risk more open, integrated markets Through our trading activities, we play a activities under one roof, creating a management, we also engage in proprietary Over the last few years, Europe’s national vital role in ensuring fair prices and secure strategically focused business with a single, trading. Our centralised approach, which energy markets have been steadily energy supplies for millions of customers integrated view of Europe’s increasingly combines our integrated market view with consolidating into a number of multi-country across Europe. interconnected energy markets. our outstanding asset portfolio, enables market regions. This ongoing liberalisation With around 1,000 dedicated energy Based in state-of-the-art headquarters us to better manage commodity risk, professionals from more than 45 countries, in Düsseldorf, Germany, our seasoned maximise value from our assets and create we create value by managing the commodity multinational teams work side by side, additional growth. price risks faced by E.ON and its customers, sharing knowledge and combining cross- E.ON’s portfolio of renewable and efficient while optimising the operation of Europe’s commodity and cross-regional expertise conventional generation assets is the most broadest and most diverse power and gas asset to optimise our asset base and find new geographically and technologically diverse base. We also have the market knowledge opportunities across the wholesale energy in Europe. This diversity creates significant NOTand industry expertise FOR to identify andREPRODUCTION capture markets. Our teams come from diverse NOTopportunities forFOR optimisation across REPRODUCTION national new opportunities presented by the world’s backgrounds, but a commitment to and regional boundaries. Our power plants, increasingly interconnected energy landscape. high performance and a willingness to which we previously managed by country, As one of the market’s leading participants, exchange new ideas. Working 24 hours a day, now form a truly European portfolio that is we traded almost 1,500 terawatt hours (TWh) 365 days a year, we’re active on 18 exchanges run centrally and can respond quickly and of power, about 2,000TWh of natural gas, and in more than 40 countries. efficiently to market price movements. Our

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Globalisation of commodity markets As energy markets across Europe converge and integrate, they are also being driven by global factors. Over the last few years, natural gas has gone from being a pipeline-based European market to a truly global business. This development has been driven largely by the emergence of shale gas in North America, which has significantly reduced US demand for LNG. As a result, the availability of LNG helps markets become more liquid, prices and Germany recorded the strongest growth shipments to Europe and Asia has increased. more transparent and risks more quantifiable. in 2010. The Title Transfer Facility (TTF) LNG now serves as a price bridge between This is important because well-functioning Point in the Netherlands has the highest markets in Europe, North America and markets will play an important role in trading volume in continental Europe, and Asia, helping natural gas to become a global delivering secure energy supplies at fair NetConnect Germany (NCG) the strongest commodity like hard coal or petroleum. prices, while helping to encourage much- growth. The number of active traders at The trend towards globalisation is also needed investment in the next generation of NCG has also increased significantly in driven by the growing commodity appetite climate-friendly technology. recent years. in Asia – particularly China. New highly As an example, the power markets of Like power trading, gas trading clearly competitive global markets are emerging Germany, Benelux, France and Scandinavia reflects the convergence and integration of that make it possible, and necessary, to were coupled in November and December European markets. This process of integration across continents. In line with these Built to lead 2010. This marked a milestone on the road to was supported by the increased volume of global developments, we completed our Over the last three years we have built a new, a European Union (EU)-wide internal power liquefied natural gas (LNG) offloaded at first financial transaction in the US natural strategically focused international trading market. Governments, regulators and market European terminals, which contributed to a gas market in May 2010. Going forward, business. Our streamlined approach now participants, including E.ON, worked for high price correlation between Continental we intend to expand these activities in places us in an unrivalled to capitalise years to create a single, uniform marketplace spot markets. order to better understand and optimise the on growth and hedge risk in European and by simplifying procedures and eliminating E.ON has been a major player at Western correlation between markets on both sides of increasingly global energy markets. trading barriers between countries. Spot Europe’s gas hubs for many years and, as the Atlantic. As a market leader, we also have the power prices across the region have been market-maker at NCG in Germany, has knowledge and expertise to contribute almost identical since the launch of market actively fostered liquidity and reliable pricing. Building trust in markets to the development of more competitive, coupling, signalling that the EU’s vision of E.ON Energy Trading also supports the As the world recovers from the economic better-functioning markets in Europe and establishing a single internal power market by development of hubs in France, Italy, Austria crisis, it’s more important than ever for will continue to support the European 2014 is starting to take shape. and in the emerging markets of central and energy markets to become more integrated Commission’s objective of ongoing Developments on wholesale gas markets eastern Europe such as Hungary, the Czech and open. As one of Europe’s leading market liberalisation, which will ultimately benefit have been similarly positive with trading Republic and Romania. participants, we feel it is vital to support the European economy and consumer. volumes again increasing significantly in increased market integrity and greater 2010. Many initiatives by market participants, transparency to ensure that governments, including E.ON, have helped to increase regulators, industry and consumers have CONTACT liquidity on spot markets. The positive trend more trust in the markets and more E.ON Energy Trading SE at gas hubs across Europe is all the more confidence in their ability to help meet the Holzstrasse 6 NOT FOR REPRODUCTION NOT FOR REPRODUCTION40221 Düsseldorf noteworthy because gas demand generally significant challenges that we now face. Germany declined in the wake of the economic crisis We support this vision by consulting with T: +49 211 73275 2300 and has been slow to recover. policy-makers and regulators on measures E: [email protected] Although the UK remains Europe’s biggest to ensure the development of European www.eon-energy-trading.com gas market by far, gas hubs in the Netherlands markets continues.

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About

Glossary 2011 * As one of the oldest law firms in the US, renewable energy, coal and emissions – and Cadwalader, Wickersham & Taft LLP – founded derivatives markets. It provides counsel in 1792 – is proud of its more than 200 years of to leading US and international financial service to many of the world’s most prestigious institutions, investors, oil, power and gas institutions. Cadwalader has a rich history of companies, producers and developers, industrial participating in many of the most significant and commercial customers, trade associations, social, economic and legal issues accompanying hedge funds, commodity marketers, exchanges the growth of the US, which has led to it and organisations. In the transactional becoming one of the world’s most prominent area, Cadwalader advises on mergers and law firms. Its global influence is expanding as it acquisitions, joint ventures, securities, private advises clients with interests in Europe, South equity, structured transactions, all forms of America and the Pacific Rim. With more than finance, and restructuring. In the litigation 500 attorneys in seven offices – New York, and regulatory space, it provides seasoned London, Charlotte, Washington, Houston, counsel regarding government investigations, Beijing and Hong Kong – Cadwalader offers private disputes, and regulatory and compliance clients innovative solutions to legal and matters. Many of the leading lawyers who financial issues in a wide range of areas. comprise the team were previously affiliated with the US Commodity Futures Trading Energy and Commodities Commission, state public utility commissions Cadwalader’s leading energy and commodities and commodity trading businesses, giving them team has extensive experience in all forms of unique insight into the increasingly competitive complex transactional, litigation and regulatory and regulated industry. For more information matters involving energy and commodities – about Cadwalader’s practices and people, visit oil, gas, metals, agriculture, power, biofuels, www.cadwalader.com.

ENERGY AND COMMODITIES Contacts Paul J Pantano Jr, Chair Karen A Dewis Doron F Ezickson Washington, DC Washington, DC London +1 202 862 2410 +1 202 862 2466 +44 (0)20 7170 8525 [email protected] [email protected] [email protected]

Kenneth W Irvin Gregory K Lawrence Anthony M Mansfield Washington, DC New York Washington, DC +1 202 862 2315 +1 212 504 6171 +1 202 862 2321 [email protected] FOR [email protected] [email protected] NOT FOR REPRODUCTION

Gregory Mocek Daryl L Rice Robert G Stephens Washington, DC Washington, DC Houston +1 202 862 2322 +1 202 862 2374 +1 713 343 7575 [email protected] [email protected] [email protected] Published by energy risk ★ ★ ENERGY RISK GLOSSARY 2 0 1 1 ENERGY RISK GLOSSARY 2 0 1 1 COMMODITY RISK MANAGEMENT & TRADING COMMODITY RISK MANAGEMENT & TRADING

Actual peak day Allocation agents Ancillary services The day during which the greatest demand (Gas) Independent agents, paid for by shippers, Services that are designed to maintain the occurs in a one-year period. who calculate how much of the gas input at a reliability of power supply to end-users. A terminal belongs to each shipper. Ancillary services can include regulation, Actuals spinning reserve, non-spinning reserve and Abandonment The physical commodity a futures American Gas Association (AGA) replacement reserve. Independent system Permission given to US interstate pipelines by contract. Also referred to as the commodity Founded in 1918, the AGA represents companies operators create a market for buying and selling the Federal Energy Regulatory Commission or the physicals. involved in all areas of the transmission and ancillary services, which help control the flow (FERC) allowing for the discontinuation of distribution of natural gas in the US. of electricity and provide energy ‘reserves’ to sales, storage or transportation service along any AGA maintain reliability. portion of the pipeline system. The necessity for H see American Gas Association American Institute of FERC permission derives from Section 7 of the Certified Public Accountants Annual cap Natural Gas Act of 1938. Permission is sought Aggregator A professional association representing the In a gas buyer’s purchase agreement, there is when utility companies want to replace, update An entity that consolidates the energy accounting profession, with approximately often a limit higher than the annual contract or sell their facilities. requirements of a number of buyers and/or 370,000 members in 128 countries. quantity (ACQ), above which the seller is not H see Federal Energy Regulatory Commission sellers in order to buy or sell power in bulk. liable to sell. This is the annual cap and is usually American Petroleum Institute (API) stated as a percentage of the ACQ. Also known Absolute pricing AICPA The trade association of the US petroleum as the maximum annual quantity. Pricing an asset using reference only to its H see American Institute of Certified Public Accountants industry. The API publishes weekly information H see also MAQ exposure to fundamental sources of risk. Most on US petroleum figures, refinery common in academia. Algorithm throughput, imports, exports and stock Annual contract quantity (ACQ) A defined, finite set of steps, operations or levels. This information is divided into five The amount of gas specified in a buyer’s Acid rain procedures that will produce a particular geographical areas known as Petroleum nomination purchase contract for one year. Forms of precipitation (such as rain, snow or outcome (for example, computer programs, Administration for Defence Districts. The API Some rights, such as make-up gas and take sleet) containing high levels of sulphuric or mathematical formulas and recipes). established the system for grading crude oils by or pay, may need to be taken into account nitric acids (with pH levels below 5.5–5.6). specific gravity (API gravity). depending on the amount of gas taken versus Also includes dry deposited gases and particles Alpha H see also Energy Information Administration (EIA), the amount contracted for. that fall back to earth from the atmosphere. A measure of the difference between a fund’s API gravity According to the US Environmental Protection actual returns and its expected returns given its Annual delivery programme (ADP) Agency, approximately two-thirds of all SO2 and risk level as measured by its beta. The alpha is a American Petroleum Institute gravity A -term schedule commonly used in the one-quarter of all NOx in the US come from measure of risk-adjusted performance. An alpha H see API gravity liquefied natural gas industry for optimising electric power generation that burns fossil fuels is usually generated by regressing the , inventory and delivery planning (may also be such as coal. portfolio or mutual fund’s excess return relative American-style referred to as the annual operating plan). H see also sulphur oxides and nitrogen oxides to a benchmark index. The beta adjusts for An American-style option may be exercised at the (the slope co-efficient). The any time during its lifetime, up to and including API Accrual accounting alpha is the intercept and is also known as the on the date. It contrasts with H see American Petroleum Institute When swaps are used to hedge specific Jensen Index. European options, which can be exercised only on-balance-sheet exposures, they are often on the expiry date. A variation is the ‘semi- API #2 accounted for on an accrual basis. Under the Alligator spread American’ where options can be exercised on All Publications Index #2: a price index for coal NOTaccrual method, theFOR net payment or receiptREPRODUCTION A position consisting of a combination of put NOTonly a set number FOR of dates before expiry. REPRODUCTIONsupply cost insurance and freight Amsterdam- in each period is accrued and recorded as an options and call options that collectively create H see also European-style option Rotterdam-Antwerp. adjustment to income or expense. commissions so high that it is almost impossible H see also hedge accounting, mark-to-market to turn a profit regardless of favourable API #4 market movements. All Publications Index #4: a price index for coal shipments free-on-board Richards Bay.

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API gravity ARA Argus Atlantic Basin One of the main quality indicators for pricing Amsterdam-Rotterdam-Antwerp area – a port An independent energy news and price The geographic region that can be considered crude oil – the higher the API gravity, the and refining area in the Belgian-Dutch region. A reporting agency. as comprising all land masses (including islands) lighter the crude. cargo or barge of a refined product traded on a that lie adjacent to or within the Atlantic Ocean API gravity = 141.5/specific gravity of crude at cost, insurance and freight ARA basis means that Aromatics and adjacent waters, including the Baltic Sea, 60° Fahrenheit – 131.5 ports within this area are covered in the cost. A Compounds produced by the fractionation North Sea, Black Sea, Davis Strait, Denmark cargo traded on a free-on-board basis means the of petroleum above 80° Celsius. The most Strait, part of the Drake Passage, Labrador Sea, API regions oil can come from any of these ports. important aromatics are benzene and toluene, Mediterranean Sea, Norwegian Sea, most of the Also known as Petroleum Administration for which are used as chemical feedstocks and in Scotia Sea, Baffin Bay, Hudson Bay, Gulf of St Defence Districts (Padds). The US is divided Arbitrage gasoline production. Lawrence, the Gulf of Mexico, Caribbean Sea into five Padds for administration purposes: 1) A trading strategy to profit from market and the Weddell Sea. As applied to the energy Padd 1, eastern seaboard; Padd 2, midwest; Padd inefficiencies in price differences of a given ASCC market, the Atlantic Basin liquefied natural gas 3, southern area (Gulf Coast); Padd 4, Rocky commodity either at the same location or at Alaskan Systems Co-ordinating Council – a (LNG) market encompasses LNG producers and Mountains; and Padd 5, far west. different geographical locations. Grade arbitrage North American Electric Reliability consumers in or adjacent to the Atlantic Basin is trading the difference in the price of a Corporation affiliate. geographic area noted above. APO commodity in the same location – for example, The Atlantic Basin LNG markets can be Average price option. the difference in the prices of two sweet crudes considered to specifically include the LNG H see average options in north-west Europe. Geographical arbitrage Asian (or average) options have payoffs that producers (current and projected): Abu Dhabi, is trading the difference in the price of the depend on an average of prices for the Algeria, Angola, Egypt, Equatorial Guinea, Iran, Application service provider (ASP) same grade in different locations. Often grade underlying commodity over a period of time, Libya, Nigeria, Norway, Oman, Qatar, Russia, A company offering access to its software and geographical arbitrage are combined – rather than on the price of the commodity Trinidad & Tobago, Venezuela and Yemen. The applications via the internet, rather than for example, in transatlantic arbitrage, which on a single date. The averaging period may current and likely future LNG-consuming requiring software to be located on personal is trading the price difference between, for correspond to the entire life of the option or countries: Argentina, Belgium, Brazil, Canada, computers or internal servers. Often a less costly example, Brent crude in Europe and West Texas may be shorter. Cyprus, Dominican Republic, France, Germany, way of using software and an approach used by Intermediate in the US. This calculation will Greece, Italy, Mexico, the Netherlands, Poland, some technology vendors for the energy sector. include the cost-of-carry as well as the cost of Ask Portugal, Puerto Rico, South Africa, Spain, the alternative crude in the US. The level at which sellers are willing to sell. Turkey, the UK, the US and possibly the APX-Endex 2) Attempting to profit from differences in price H see also bid/ask Bahamas and Jamaica. A European energy exchange, operating spot when the same security, or commodity Note that an Atlantic Basin LNG producer and futures markets for electricity and natural is traded on two or more markets. Asset sweating might not be physically located in the Atlantic gas in the Netherlands, the UK and Belgium. Increasing the efficiencies of an existing Basin itself. In October 2010, a merger took place between Arbitrage-free model plant in order to avoid the need to build H see also Pacific Basin APX-Endex and Belpex, the Belgian Power Any theoretical model that does not allow new infrastructure. This strategy was pursued Exchange. Belpex is a full subsidiary of APX- arbitrage on the underlying variable. throughout the 1990s in the UK power sector At-the-beach Endex Holding BV. and the oil refining and producing sector in (UK) When gas has been brought ashore to ARCH the West. a terminal by producers but is not yet in the APX Power UK Autoregressive conditional heteroskedasticity. national transmission system, the gas is called An electronic exchange that launched electricity Associated gas at-the-beach. futures in June 2000. Trading includes spot Area price Hydrocarbon gases found in a crude oil reservoir, NOTphysical electricity FOR contracts, prompt powerREPRODUCTION The price of electricity in one particular region NOTseparate from or FORin solution with the REPRODUCTIONoil. contracts and cleared forward contracts, and within an integrated grid, such as Nord Pool. is open to companies active in the UK power H see also system price market. In 2003, it was bought by APX Group, the energy exchange for gas and power formerly known as UKPX.

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At-the-money Average options Baltic Exchange 1) At-the-money spot – an option whose strike Average rate option or average price option – a A membership exchange located in London for Barrier options are exotic options that is the same as the prevailing market price of the form of Asian option whose payoff is linked to the maritime bulk freight market. either come to life (are ‘knocked-in’) or are underlying rate or price. the average value of the underlying asset over extinguished (‘knocked-out’) under conditions 2) At-the-money forward – an option whose a specified period of time. Although somewhat Banging the close stipulated in the option contract. The conditions strike is at the same level as the prevailing more complex to price relative to traditional 1) A form of where a are usually defined in terms of a price level market price of the underlying . European or American option structures, uneconomically buys or sells futures contracts (barrier, knock-out or knock-in price) that may H see also in-the-money average rate options are popular since they during the closing period. This is done to benefit be reached at any time during the lifetime of provide a price hedge that better matches price futures positions purchased earlier in the day or the option. Auctioning exposures that are based on daily averages, such positions in a that is cash-settled based There are four major types of barrier options: As applied to the energy sector, auctions as a as purchase/consumption of energy on a daily on the futures price of that day. up-and-out, up-and-in, down-and-out and pricing mechanism have been used or have been basis. Also referred to as an APO. 2) Violating bids or offers to artificially mark the down-and-in. The extinguishing or activating planned for liquefied natural gas storage capacity, H see Asian option closing price. features of these options mean they are emission allowances and transmission capacity, in usually cheaper than ordinary options, making order to manage congestion. Aviation gasoline (AVGAS) Banking them attractive to buyers looking to avoid A high-octane aviation fuel used for aircraft and A procedure by which excess gas that one high premiums. Australian Energy Market Operator (AEMO) racing cars. shipper cannot use is lent to another shipper to The organisation responsible for the be returned at a later date. Baseload administration and operation of the wholesale The minimum expected customer power national electricity market in Australia in Bare-boat charter requirements at a given time. Baseload power accordance with the National Electricity Law A chartering arrangement whereby a vessel is generally supplied from larger plants, which and Rules. AEMO’s aim is to provide an effective is contracted without crew or provisions, and cannot be ramped up and down as quickly as infrastructure for the efficient operation of the B can have distinctions or implications in terms peaking generation plants. As baseload demand Australian wholesale national electricity market. Back month of legal responsibility relative to other types of is generally predictable and steady, it is less Back-month contracts are those exchange- charter arrangements. expensive than peak power. Australian Securities Exchange (ASX) traded derivatives contracts with the most The primary group in Australia, distant delivery dates or expirations. For a suite Barge Baseload generation created by the merger of the Australian Stock of 12 monthly contracts, for example, the last Motored or motorless vessel used to carry oil Electricity-generating equipment normally Exchange and the Sydney in three months might be back months. Also products, often along a river. Barges vary in operated to serve loads on an around-the- July 2006. referred to as deferred months. capacity, usually from 1,000 to 5,000 tonnes. clock basis.

Autocorrelation Backwardation Barrel Basis The correlation between a component of a When the price of nearer (typically prompt or Standard measure of quantity for crude oil and The differential that exists at any time between stochastic process and itself lagged a certain spot) crude or another underlying commodity petroleum products. US barrel and standard the cash – or spot – price of a given commodity period of time. or instrument trades at a premium to the barrel are both equal to 42 US gallons or and the price of the nearest for same commodity or instrument traded further 159 litres. the same (or related) commodity. The basis may Available transfer capability (ATC) forward. Also known as an inverse. reflect different time periods, product forms, A measure of the transfer capability remaining H see also Barrels of oil equivalent (BOE) qualities or locations. The cash price minus the in the physical transmission network for further Volume of natural gas expressed in terms of its futures price equals the basis. NOTcommercial activity FOR over already committed REPRODUCTION Balancing mechanism NOTenergy equivalent FOR to oil. About 6,000 REPRODUCTION cubic feet uses. ATC is the total transfer capability, less the In an electricity grid or natural gas pipeline of gas equals one BOE. transmission reliability , the sum of existing network, the means of ensuring that supply does transmission commitments (including retail not outstrip demand, or vice versa. customer service) and the capacity benefit margin. H see also capacity benefit margin

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Basis risk Belpex Bilateral contract is the risk that the value of a futures An option that enables the purchaser to buy H see APX-Endex A contract directly between two parties. contract (or an over-the-counter hedge) will or sell a basket of commodities. The value not move in line with that of the underlying of a basket option is dependent on both the Benchmark crude Bilateral netting exposure. Alternatively, it is the risk that the cash of the individual commodities and the Synonymous with reference crude or marker An agreement between two counterparties to futures spread will widen or narrow between the correlation between the prices of commodities crude. A crude oil whose price is used as a offset the value of all in-the-money contracts times at which a hedge position is implemented in the basket. reference against which other crudes are priced. with all out-of-the-money contracts, resulting and liquidated. Because of their liquidity, the Nymex West Texas in a single net exposure amount owed by one There are various types of basis risk. For Basket Intermediate and IntercontinentalExchange/ counterparty to the other. example, a heating-oil wholesaler selling its A swap in which the floating leg is based on the ICE Futures’ Brent crude oil futures contracts H see also multilateral netting, netting product in Baltimore will be exposed to basis returns on a basket of underlying commodities. are used as global benchmarks. Dubai crude is risk if it hedges using New York Harbor heating widely used as a benchmark for Middle Eastern Bill of lading (b/l) oil futures contracts listed by Nymex. This is a Basra Light crudes, especially for sale to Asian markets. A shipowner’s receipt for its cargo, which ‘locational’ basis risk. A crude oil produced in southern Iraq that H see also marker crudes includes cargo details, such as loading times. Other forms of basis risk include ‘product’ contains approximately 2% sulphur by weight basis, arising from mismatches in type or quality with an American Petroleum Institute gravity of Beta of hedge and underlying (for example, hedging about 34. The beta (or beta co-efficient) of a rate or H see digital option jet fuel with heating oil); and ‘time’ or ‘calendar’ price is the extent to which that rate or price basis (for example, hedging an exposure to Bbl follows movements in the overall market. If Binomial model physical prices in December with a January Abbreviation for barrel. the beta is greater than one, it is more volatile Any model that incorporates a binomial tree, futures contract). than the market; if the beta is less than one, it is also called a binomial lattice. A binomial model Bcf less volatile. describes the evolution of a random variable Billion cubic feet (of gas). over a series of time steps, assigning given Basis swaps are used to hedge exposure to basis Betta probabilities to a rise or fall in the variable. risk, such as locational risk or time-exposure B/d, bd or bpd British Electricity Trading and Transmission After the initial rise or fall, the next two risk. For example, a natural gas basis swap could Barrels per day. Used to express crude oil Arrangements – arrangements designed to branches will each have two possible outcomes, be used to hedge a locational price risk: the production, refinery throughput capacity draw Scotland into the British wholesale so the process will continue, building a ‘tree’ seller receives from the buyer a Nymex division (i.e., capacity of the crude distillation unit), market for trading power and create a single, over time. The process is usually specified, settlement value (usually the average of the last liftings, forward demand projections and crude integrated British-wide competitive wholesale so that an upward movement followed by a three days’ closing prices) plus a negotiated fixed consumption rates. electricity market. Betta was implemented on downward movement results in the same price, basis, and pays the buyer the published index April 1, 2005. It gives renewable generators so the branches recombine. value of gas sold at a specified location. Beach gas in Scotland better access to the Anglo-French Binomial trees are of interest because they can (UK) Gas produced offshore and brought interconnector, making it easier to sell power in be used to deal with American-style features; the Basis trading onshore to the shore/beach gas terminal, but continental Europe. early- condition can be tested at each A trading strategy whereby trades are placed not yet part of the national transmission system. H see also New Electricity Trading Arrangements point in the tree. simultaneously in a derivative contract, normally a future, and the underlying asset. The purpose is Bear market BFOE either to cover derivatives sold or to attempt an A market in which the trend is for prices H see Brent, Forties, Oseberg, Ekofisk arbitrage strategy. This arbitrage can either take to decline. NOTadvantage of an existingFOR mispricing (inREPRODUCTION cash- NOTBid/ask FOR REPRODUCTION and-carry arbitrage) or be based on speculation A measure of market liquidity, also known as that the basis risk will change. An option spread trade that reflects a bearish bid/offer. The bid is the price level at which view on the market, usually the purchase of a buyers are willing to buy, and the ask is the put spread. price level at which sellers are willing to sell. H see also , call spread, put spread The thinner the spread, the higher the liquidity.

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Biodiesel Bloomberg Bottleneck Broker A fuel typically made from soybean, canola An information service, news and media Caused when the flow of electricity is An intermediary between traders for physical, or other vegetable oils, animal fats and company that provides business and financial greater than the system capacity between two futures and over-the-counter transactions recycled grease. It can serve as a substitute for professionals with the tools and data on a single, connected grids. Bottlenecks can lead to an including options, futures and swaps. petroleum-derived diesel or distillate fuel. For all-inclusive platform. area becoming isolated. In an exchange, this can environmental impact assessment reporting, cause attendant price imbalances between the Brownfield it is a fuel composed of mono-alkyl esters of BOE area price and system price. Abandoned or unused industrial and commercial long-chain fatty acids derived from vegetable H see barrels of oil equivalent sites that may be used for redevelopment oils or animal fats, designated B100 and meeting Box or expansion. Such use, however, may be the requirements of the American Society for Boil-off To buy/sell mispriced options and hedge the complicated by environmental contamination. Testing materials. Gas vapour that is typically produced during using only options, unlike the liquefied natural gas (LNG) ship unloading or conversion or the reversal, which use futures Brownian motion Biomass energy LNG transport or storage phases as a result of contracts. If a certain strike put is underpriced, H see Wiener Process Energy produced by the combustion of plants, heat input or pressure variations. the trader buys the put and sells a call at the vegetation or agricultural waste – for example, same strike, creating a synthetic futures Brownout rice husks. Boiling point position. To get rid of the market risk, the trader A partial loss of power caused by unexpected high The temperature at which a liquid becomes a gas. sells another put and buys another call, but at demand or problems with the physical delivery Blackout different strike prices. of electricity. A brownout may result in lights A total loss of power caused by the failure of the Bona fide hedge exemption H see also conversion, reversal dimming or electrical machinery slowing down. generation, transmission or distribution system. A trader may exceed position limits set by the Commodity Futures Trading Commission if: Btu Black-Scholes model the transaction or position is a substitute for An options market arbitrage, in which both a H see British thermal unit An option-pricing model initially derived by transactions in a physical marketing channel; it bull spread and a bear spread are established for Fischer Black and Myron Scholes in 1973 for is an economically appropriate means of risk a riskless profit. Bulk power supply securities options and later refined by Black in reduction; it arises from the potential change The infrastructure and generating plant generating 1976 for options on futures. in the value of assets, liabilities or services; it Brent blend crude oil power for a region’s wholesale power supply. reduces risks resulting from a swap that was UK Brent blend is a blend of crude oil from Blending executed opposite a counterparty for which the various fields in the East Shetland Basin between Bull market (Gas) Mixing gases of different specifications to transaction would qualify as a bona fide hedging Scotland and Norway in the North Sea. The A market in which the trend is for prices produce one within the required gas specification. transaction under the first three criteria; or it crude is landed at the Sullom Voe terminal and to increase. (Crude) Sometimes crudes are blended near reduces risks resulting from a swap that satisfies is used as a benchmark for the pricing of much source when the same storage terminal or the first three criteria. of the world’s crude oil production. Bull spread pipeline is used. An example is Brent blend – a H see also dated Brent An option spread trade that reflects a bullish blend of crudes from various fields in the East Book view on the market, usually the purchase of a Shetland Basin. Also used to create components The total of all forward positions held by a Brent, Forties, Oseberg, Ekofisk (BFOE) call spread. for gasoline. trader or company. The BFOE market, also known as the 21-day H see also bear spread, call spread BFOE market, is an over-the-counter forward Block trade Book transfer or booking out market whereby buyers and sellers trade cargos A large transaction that is negotiated off The transfer of title of a cash commodity of Brent, Forties, Oseberg or Ekofisk. NOTan exchange’s trading FOR facility and then REPRODUCTION to the buyer without a corresponding NOT FOR REPRODUCTION posted on the trading facility. These trades physical movement. British thermal unit (Btu) must be conducted as specified by specific The amount of heat required to raise the exchange rules. temperature of 1lb of water by 1° Fahrenheit (from 60°F to 61°F). It is used to compare the heat-producing value of different fuels.

★ ★ ENERGY RISK GLOSSARY 2 0 1 1 ENERGY RISK GLOSSARY 2 0 1 1 COMMODITY RISK MANAGEMENT & TRADING COMMODITY RISK MANAGEMENT & TRADING

Bundesnetzagentur (BnetzA) Bundled services Call spread The German Federal Network Agency for Two or more electricity or gas services provided An options position formed by the purchase electricity, gas, telecommunications, post and at a combined charge – for example, gas of a at one level and the sale of a railway, headquartered in Bonn, provides for transportation and storage, electricity generation C call option at some higher level. The premium the further development of the electricity, gas, and transmission. received by selling one option reduces the cost telecommunications and postal markets and, C and F of buying the other, but participation is limited since 2006, also of the railway infrastructure Bunker C Cost and freight. The price includes the cost of if the underlying goes up. market. In order to implement effective A heavy fuel oil used to power ships, for the cargo and the freight/vessel hiring costs, but H see also bear spread, bull spread, put spread, regulations, the agency has the authority to electricity generation and for large-scale not the insurance. Also referred to as CAF. obtain information and conduct investigations, industrial use. It is often the residue from as well as the right to impose graded sanctions. vacuum distillation blended with lighter Callable swap components. Calendar spreads, or time spreads, describe the A swap in which the fixed-rate payer has the Bundeskartellamt price differential – or spread – that may arise right to terminate the swap after a certain time The German Federal Cartel Office. Enforcing Business day between differently dated futures contracts. if rates fall. Often done in conjunction with the ban on cartels is one of the prime functions (US) For electricity utilities, as determined For example, the price difference between callable debt issues, where an issuer is more of the Bundeskartellamt, including combating by the North American Electric Reliability contracts for first- and second-month light, concerned with the cost of debt than the such practices as agreements between companies Corporation (Nerc), the business day typically sweet crude offered on Nymex. Time spreads maturity. In some definitions of a callable swap, on the setting of prices or sales quotas and begins at 06:00 for a 24-hour period. Holidays can be mitigated by purchasing options on the the fixed-rate receiver has the right to terminate market sharing. are also determined by Nerc and may be difference between average annual prices. In the swap. Also known as a cancellable swap. separate from US-designated holidays. effect, such options provide protection against a Bundled derivative reshaping of the curve. Calorific value (CV) A derivative contract that combines two or spread The term is also used for trading in which the A measure of the energy released as heat when more commodities to manage a number of The simultaneous purchase of an out-of-the- parties buy a certain number of futures contracts a fuel is burned. It may be measured wet (with related risks. For example, coal for power money and sale of an at-the-money for a specific month and simultaneously sell water vapour) or dry (after the water vapour has linked to pollution , where the contract . The buyer profits if the underlying the same number of futures contracts for a been removed). It may also be measured gross compensates the coal user for any extra charges remains stable, and has limited risk in the event different month. or net – gross includes the heat produced when arising from the coal containing more than a of a large move in either direction. the water vapour is condensed into a liquid, and certain level of sulphur. The counterparties to California-Oregon border (COB) net does not. Generally, CV is measured gross a deal agree to settle any differences between Buyer’s nomination contract Area where the utilities of the north-west US and dry. the delivered sulphur content of the coal and A gas contract where the buyer has the option connect to those of California, and an electric an agreed benchmark in emission allowances. to nominate the delivery requirements up to the power price index point. Cancellable swap The coal user is paid when the sulphur content predefined delivery capacity. The seller is obliged, H see callable swap is above the benchmark and pays out when it under this type of contract, to deliver as requested, Call option is below. although limits are often built into the contract. An option that gives the buyer (holder) the Cap right, but not the obligation, to buy a futures A supply contract between a buyer and seller, Bundled rate Buy side contract (enter into a long futures position) or whereby the buyer is assured that he or she will A combined charge for the provision of A term that describes financial institutions such physical commodity for a specified price within not have to pay more than a given maximum two or more services – for example, gas as pension funds and investment funds whose a specified period of time in exchange for a price. This type of contract and a call option are transportation and storage, or electricity primary business is to buy investments on behalf one-time premium payment. analogous. NOTgeneration and transmission.FOR REPRODUCTIONof other investors. The opposite of sell side. NOTIt obligates the FOR seller (writer) of the REPRODUCTION option to H see also sell side sell the underlying futures contract (enter into a short futures position) or commodity at the designated price, should the option be exercised at that price. H see also

★ ★ ENERGY RISK GLOSSARY 2 0 1 1 ENERGY RISK GLOSSARY 2 0 1 1 COMMODITY RISK MANAGEMENT & TRADING COMMODITY RISK MANAGEMENT & TRADING

Capacity Capacity trading Carry forward Cash market (Electricity) The rated load-carrying capability Where a gas shipper with spare capacity in a (Gas) If, in a given contract period (often a H see of electrical equipment such as generators transportation system – for example, the UK’s year), a buyer has taken more than the annual or transmission lines, typically expressed in national transmission system – sells or leases its contact quantity then, if there is no accumulated Catalyst megawatts or megavoltamperes. rights to transport gas in a pipeline. make-up gas, the buyer can carry forward A substance that accelerates or facilitates (Gas) The rated transportation volume of natural (US) Trading of transportation rights that has this excess for future use. The buyer may use a chemical reaction without changing the gas pipelines, typically expressed in millions of been facilitated through the use of electronic the carry forward to offset the take-or-pay substance itself – for example, the use of cubic feet per day. bulletin boards or electronic data interchange. obligation, although there may be a limit to the platinum in reformers to convert naphtha amount of carry forward allowed in any given into gasoline. Capacity benefit margin (CBM) Capital adequacy contract period. The amount of transmission transfer capability An estimate of the capital required to maintain Cat cracking/catalytic cracking reserved by load-serving entities to ensure access a business. Carrying charge Catalytic cracking is a refining process that to generation from interconnected systems to The total cost of storing a physical commodity, breaks down heavier crude oil fractions meet generation reliability requirements. Capped swap including storage, insurance, interest and into motor spirit and gasoil/heating oil Reservation of CBM by a load-serving A in which the floating opportunity cost. blending components by passing them over a entity allows that entity to reduce its installed payments of the swap are capped at a certain suitable catalyst. generating capacity below a level that may level. A floating-rate payer can thereby limit its Cascading otherwise have been necessary without exposure to rising commodity prices. The conversion of a forward contract into a CCGT interconnections to meet its generation series of shorter-term contracts on maturity. H see combined-cycle gas turbine reliability requirements. Captive customer H see also available transfer capability One who has no practical means of buying Cash-and-carry arbitrage CDM power or gas from a source other than the local A strategy whereby a trader generates a riskless H see Clean Development Mechanism Capacity charge utility, even if in theory the customer is based in profit by selling a futures contract and buying In gas or electricity markets, a price based on a competitive energy market. the underlying to deliver into it. The futures Centistoke reserved capacity or measured demand and contract must be theoretically expensive relative One of the many ways of expressing the

irrespective of energy delivered. Also known as Carbon dioxide (CO2) to the underlying. If the futures are theoretically viscosity of fuel oil. demand charge. A gas produced by the burning of fuel. Many cheap compared to cash, the trader could sell scientists believe it to be a major contributor to the underlying and buy the futures – in reverse Certificate of Public Convenience Capacity factor the greenhouse effect. cash-and-carry arbitrage. and Necessity The amount of energy that a power A certificate issued by the Federal Energy generation plant actually generates compared Carbon-dioxide equivalent Cashflow hedges Regulatory Commission that allows the to its maximum rated output, expressed as a The accepted measurement unit for greenhouse In US accounting terminology, a hedge of a recipient to engage in the transportation and/ percentage. gases under the Kyoto Protocol. forecasted asset and liability acquisition for which or sale of natural gas in interstate commerce, the gain or loss on the hedging instrument will or to acquire and operate facilities needed to Capacity option Carbon sequestration remain in equity when the asset or liability is accomplish the same. The right to access the output of a plant, whose Capturing carbon dioxide in carbon sinks, thus acquired. That gain or loss will subsequently be generation is specifically earmarked. limiting its presence in the atmosphere. included in net profit or loss in the same period Certified Emission Reduction (CER) as the asset or liability affects net profit or loss. The right to emit 650,000 tonnes of CO2. CER Carbon sinks H See also FAS 133 is the technical term for the output of Clean NOTCapacity purchase FOR agreement (CPA) REPRODUCTIONForests, soils or oceans that store more carbon NOT FOR REPRODUCTIONDevelopment Mechanism (CDM) projects, as A legal document for transferring transmission dioxide than they release, thereby limiting the Cashflow-at-risk defined by the Kyoto Protocol. A unit of green- capacity for a defined period. gas’ contribution to the greenhouse effect. Value-at-risk (VaR) calculated in terms of house gas reductions that has been generated Carbon sinks can be used as part of an emissions earnings or cashflow, giving a probability that and certified under the provisions of Article 12 trading system. business targets will be met. A useful VaR tool of the Kyoto Protocol, the CDM. for non-financial institutions.

★ ★ ENERGY RISK GLOSSARY 2 0 1 1 ENERGY RISK GLOSSARY 2 0 1 1 COMMODITY RISK MANAGEMENT & TRADING COMMODITY RISK MANAGEMENT & TRADING

CFD Chicago Climate Exchange (CCX) Clean Development Mechanism (CDM) CNSE H see contract for differences Greenhouse gas emissions trading exchange; The CDM, defined in Article 12 of the Kyoto H see Comisión Nacional de Sistema Eléctrico designed for voluntary emissions reductions Protocol, allows a country with an emission- Chain and trading fr all six greenhouse gases. The reduction or emission-limitation commitment Coal freight rates A forward contract for the delivery of a CCX administers the first multinational and under the Kyoto Protocol (Annex B Party) to Used to express coal transportation cost. Usually commodity that has been traded many times by multisector market for reducing and trading implement an emission-reduction project in listed as dollars/tonne or dollars/tonne-mile. several parties, thereby forming a chain between greenhouse gas emissions. CCX is a self- developing countries. Such projects can earn the final buyer and the initial seller. regulatory, rules-based exchange designed and saleable Certified Emission Reduction credits, Coal gasification governed by CCX members that have made each equivalent to one tonne of CO2, which A process for converting coal partially or Charter party a voluntary, legally binding commitment to can be counted towards meeting Kyoto targets. completely into combustible gases, for use as A contract by which the owner of a vessel reduce their emissions of greenhouse gases. fuels or chemical feedstocks. (aircraft or ship) leases his craft to or hires a Clean spark spread charterer for a fixed period of time or a set Chicago Mercantile Exchange (CME) The spread equal to the regular (or ‘dirty’) spark Co-efficient of determination number of voyages. Normally, the vessel owner The largest derivatives exchange in the US, spread minus the CO2 emissions cost for gas- A measure of the proportion of variance in y retains rights of possession and control while owned by the CME Group. fired power plants. This spread then represents which can be explained by x. the charterer has the right to choose the ports the net revenue on power sales after gas costs and H See also r2 of call. It also goes under the name of charter emissions allowance costs. An analogous spread for agreement or charter contract. The holder of a chooser option can choose, coal-fired generation plants is typically referred to Co-firing after a predetermined period, between a put and as a clean dark spread or a dark green spread. Burning natural gas as well as another fuel type Charter rate a call option. Similar to a straddle, but cheaper, H see also dark spread, spark spread (usually coal) in order to decrease the amount of The shipping rate agreed between the owner of because the holder must choose between the air pollutants and/or use the most competitively a vessel and the person or firm wanting to use put or the call before the instrument expires. Cleared swap priced fuels available. the vessel in a charter party agreement. H see also Any swap that is directly or indirectly H see also dual-firing submitted to be cleared by a derivatives clearing CHP organisation registered with the Commodity Co-generation A market participant who uses technical analysis H see combined heat and power Futures Trading Commission. H see combined heat and power to chart the price patterns of commodities, and bonds to make buy and sell decisions. CIF Clearing Co-generator Chartists believe recurring patterns of trading H see cost, insurance and freight A mechanism by which transactions are settled A generating facility that produces electricity can help them forecast price movements. through an organisation that assures settlement. and another form of useful thermal energy Clean coal technology (such as heat or steam), used for industrial, Charterer Methods of burning coal with reduced emissions. Clearing members commercial, heating or cooling purposes. A person or firm who enters into a charter Members of an exchange who accept party agreement with the owner of a vessel for Clean dark spread responsibility for all trades cleared through them. the transportation of cargo for a set period of Refers to the profit realised by a power H see derivatives clearing organisation A supply contract between a buyer and a seller time or number or voyages. generator after paying for the cost of coal fuel of a commodity, whereby the buyer is assured and carbon allowances. CNG that he will not have to pay more than some H see clean spark spread Compressed natural gas – natural gas that has maximum price and whereby the seller is been compressed under high pressure (typically assured of receiving some minimum price. NOT FOR REPRODUCTION NOT2,000–3,600psi). FOR REPRODUCTION H see compressed natural gas Collateral An obligation or security linked to another CNS obligation or security to secure its performance. Central North Sea.

★ ★ ENERGY RISK GLOSSARY 2 0 1 1 ENERGY RISK GLOSSARY 2 0 1 1 COMMODITY RISK MANAGEMENT & TRADING COMMODITY RISK MANAGEMENT & TRADING

Combined-cycle gas turbine (CCGT) Commercial risk Commodity pool An energy-efficient gas turbine system, where The risk a company takes by offering Any investment trust, syndicate or similar form An option allowing its holder to buy or sell the first turbine generates electricity from the with no collateral. of enterprise operated for the purpose of trading another option for a fixed price. For example, the gas produced during fuel combustion. The hot in commodity interests. purchase of a European-style ‘call on a put’ means gases pass through a boiler and then into the Commissioning gas that the compound option buyer obtains the right atmosphere. The steam from the boiler drives Gas produced when a new field starts up, or Commodity pool operator (CPO) to buy on a specified day (when the overlying the second electricity-generating turbine. the gas needed during the start-up of a power A person engaged in a business similar to an option expires) a put option (the underlying station. In both cases, the amount and timing of investment trust or a syndicate and who solicits option) at the overlying option’s . Combined heat and power (CHP) the requirements are not exact. or accepts funds, securities or property to trade The production of two forms of energy, such as commodity futures contracts, commodity Compressed natural gas (CNG) high-temperature heat and electricity, from the Commodity options or commodity swaps. Either the CPO A product consisting of natural gas that has same process. For example, the steam produced 1) A physical good that can be the object of a or a commodity trading adviser makes trading been compressed under high pressures, typically from boiling water could be used for industrial commercial transaction. decisions on behalf of the pool. between 2,000 and 3,600psi, and is held heating. In the US, the term typically used for 2) Any index, rate, currency, physical good or in a hard container. It is used mainly as an this process is co-generation. other goods or articles that are, or could be, the Commodity trading adviser (CTA) alternative fuel for internal combustion engines underlying instrument or price determinant of a An entity that, for pay, regularly gives people (such as automobile engines). It generates low Combustion turbine futures contract or other . advice on options, futures, swaps and the hydrocarbon emissions but a significant quantity An electricity generator that uses a jet engine actual trading of managed futures accounts. of nitrogen-oxide emissions. CNG’s volumetric as the prime mover. Often fuelled by natural Commodity future Registration for CTAs with the Commodity energy density is about 42% of liquefied natural gas or petroleum products and used as A futures contract on a commodity. An Futures Trading Commission is done through gas’s and 25% of diesel’s. peaking generation. agreement to buy or sell a specific amount the National Futures Association. of a commodity or financial instrument at a Compressor station Co-mingled particular price at a future date. Commodity swap Gas loses pressure as it travels over long When a gas or crude oil outside contract Commodity swaps enable both producers and distances. A compressor station – usually a specifications has been mixed with another Commodity Futures Modernisation Act consumers to hedge commodity prices. The gas turbine engine – is an installation that gas to bring it within the required quality US legislation designed to re-invigorate the consumer is usually a fixed payer and the producer recompresses the gas to the required pressure. specifications. derivatives sector by modernising the law a floating payer. If the floating-rate price of the for futures, swaps and other derivatives. The commodity is higher than the fixed price, the Compulsory stocks Comisión Nacional de Sistema Eléctrico (CNSE) legislation has caused some controversy among difference is paid by the floating payer, and vice Crude oil and product stocks that an oil company A regulatory commission for the Spanish US energy exchanges in that it excludes some versa. Usually only the payment streams, not is obliged to hold by the consuming government. power industry. Attached to the ministry electronic trading systems from regulatory the principal, are exchanged, although physical of industry and energy, the Madrid-based oversight under the Act. delivery is becoming increasingly common. Condensates CNSE has regulatory and executive powers Swaps are sometimes done to hedge risks Mixtures of liquid hydrocarbons mainly to regulate operation of the industry and Commodity Futures Trading that cannot readily be hedged with futures recovered from gas reservoirs. They may include supervise industry practices. Commission (CFTC) contracts. This could be a geographical or liquified petroleum gases (propane and butane), An independent agency of the US government quality basis risk, or it could arise from the naphtha and gasoil or only some of the above Commission de Régulation de l’Energie (CRE) that has the authority to regulate the US maturity of a transaction. fractions. Condensates are used both as refinery The French regulatory agency for energy. Acts commodity and derivatives markets. The and petrochemical feedstocks. as the guarantor of the right of access to public commission is composed of five commissioners Common carriage NOTelectricity grids andFOR to natural gas facilities REPRODUCTION and is responsible for assuring fairness, NOTH see third-party accessFOR REPRODUCTIONConfidence interval and systems. transparency and well-functioning of markets. A confidence interval for an unknown Component value-at-risk population parameter is an interval constructed Commercial end-user An approximation to value-at-risk, whereby the from a given set of sample data in such a way H see end-user calculation is based on the principal components that the probability that the interval contains the of a portfolio. true value of the parameter is a specified value.

★ ★ ENERGY RISK GLOSSARY 2 0 1 1 ENERGY RISK GLOSSARY 2 0 1 1 COMMODITY RISK MANAGEMENT & TRADING COMMODITY RISK MANAGEMENT & TRADING

Congestion Contract customer Convenience Co-operative Physical constraints at certain points on A gas buyer who negotiates terms with the According to the modern theory of term (US) A group organised under law into a electricity transmission networks. seller, unlike small domestic users who pay by structures in commodity prices, convenience utility company that will generate, transmit or fixed tariff. yield describes the yield that accrues to distribute supplies of electricity to a specified Contango the owner of a physical inventory but area not being served by another utility. Typically, A market situation in which the value of Contract for differences (CFD) not to the owner of a contract for future a co-operative is a not-for-profit organisation the spot price in the future is higher than 1) a long-term swap agreed bilaterally, generally delivery. It represents the value of having where the customers are also owners. the current spot price. When a market is in between generators and electricity supply the physical product immediately to hand contango, market participants expect the spot companies, and referenced to prices in the and offers a theoretical explanation, albeit of Co-ordination transactions price to go up. The reverse situation is described relevant pool. limited predictive value, for the strength of These are short-term transactions undertaken as backwardation. 2) a short-dated swap agreement used to backwardation in the commodity markets. chiefly to maintain the integrity of an H see also backwardation minimise the basis risk between the daily electricity system. published Platt’s quote for dated or physical Conversion Contingency order Brent in a specific time window in the future A delta-neutral arbitrage transaction involving Correlation An order that becomes effective only on and the forward price quote for a specific a long futures contract, a long put option and a A measure of the degree to which changes in fulfilment of a predefined condition. month. Settlement of a CFD is based on the short call option. The put and call options have two variables are related. Correlation ranges published price difference at a designated time. the same strike price and same expiration date. between +1 (perfect correlation – the same Contingent claim H see also box, reversal amount of movement in the same direction) and A term used in theoretical models to refer to Contract month -1 (perfect negative correlation – the same derivative contracts, typically options, which H see delivery month Conversion factors amount of movement in opposite directions). entitle a payoff provided some other related Conversion factors depend on the specific Like volatility, it can be calculated from market conditions occur. Contract path gravity of the crude oil. As a general guide: historical data, but such calculations are not Electricity transmission path for a generation ● 1 tonne of crude = 7.5 barrels necessarily good predictors of behaviour. Contingent premium option transaction that is specified by contract but that ● 1 barrel of crude = 5,604 cubic feet of natural If the correlation between markets is known, An option for which no upfront payment of may not take into account loop flows through gas, 0.996 barrels of gasoil or 1.446 barrels of an option position in one market can be offset premium is required and, therefore, the buyer neighbouring systems. liquefied petroleum gas against another with similar direction and pays no premium unless the option is exercised. ● 1 US barrel = 42 US gallons = 158.978 litres volatility. This is advantageous, because it can As a rule of thumb, the premium eventually paid Control area ● 1 million barrels of crude a day = 50 million circumvent difficult hedging environments and is equal to the premium payable on a normal (US) A large geographic area within which a tonnes a year can reduce costs. option, divided by the option delta. Hence, utility, or group of utilities, regulates electricity ● 1 megajoule = 947.81 British thermal units = Correlation is also important for the pricing the price increases dramatically for out-of-the- generation in order to maintain scheduled 238.85 Kcal of some options, particularly those offering money options. interchanges of power with other control areas ● 1 cubic foot = 0.0283 cubic metres exposure to more than one market variable. and to maintain the required system frequency. H see also cubic foot The payout of a spread option or a Contingent swap option is based on the correlation between two A swap that is only activated when rates reach Control area operator Conversion rate separated by space, time or asset, a certain level or a specific event occurs. For (US) An electricity entity that operates 1 therm = 29,307 kWh while that of a product will depend example, drop-lock swaps only activate if rates generating capacity to meet area demand, on the extent of the relationship between or prices drop to a certain level or if a specified monitors actual interchange (electricity flowing Cooling degree day movements in the underlying and movements in level over a benchmark is achieved. A between control areas) and can dispatch H see degree day the . NOTis a special type ofFOR contingent swap, whoseREPRODUCTION generating resources to ensure that actual NOT FOR REPRODUCTION value and exercise are usually contingent on an interchange equals scheduled interchange. .

★ ★ ENERGY RISK GLOSSARY 2 0 1 1 ENERGY RISK GLOSSARY 2 0 1 1 COMMODITY RISK MANAGEMENT & TRADING COMMODITY RISK MANAGEMENT & TRADING

Correlation co-efficient In this structure, the holder ceases to accrue Counterparty risk A covered put option is one whereby the The correlation co-efficient (also referred to interest as soon as the spot rate leaves The risk that a counterparty to a transaction writer sells the option while holding cash. as r) provides an index of the degree to which the range. Even if the spot rate subsequently or contract will (fail to perform) on its This technique is used to increase income by variables co-vary in a linear fashion. re-enters the range, the holder does not obligation under the contract. Counterparty receiving option premium. If the market goes continue to accrue coupon interest. risk is not limited to (the risk that down and the option is exercised, the cash can Corridor A wall option is a special type of corridor the counterparty cannot fulfil its contractual be used to buy the underlying to cover. The buyer of a corridor purchases a cap with a option, where the accrual corridor is one-sided. obligations for payment) but may also result Covered put writing is often used as a way of lower strike while selling a second cap with a Another relative is the range binary, a digital from other problems associated with a target buying. If an investor has a target price higher strike. The premium earned from the sale option that pays a fixed-coupon amount if the counterparty unwilling to honor the contract. at which he wants to buy, he can set the strike of the second cap reduces the total cost of the rate stays within the range, but pays nothing if price of the option at that level and receive corridor. The buyer is protected from rates rising the range is breached. Counter-purchase market option premium to increase the yield of the above the first cap’s strike, but exposed again H see also range binary, trigger condition In a counter-purchase market, the system asset. Investors also sell covered puts if markets if they rise past the second cap’s strike. This operator buys excess power from the grid when have fallen quickly but seem to have bottomed, liability can be limited by selling a knock-out Cost base there is a surplus and sells reserve power to because of the high volatility typically received cap, rather than a conventional cap. (UK) The initial capital and running costs of the the grid when there is a shortfall. Costs to the in the option. national transmission system, used by National system operator are recouped through tariffs H see also naked option Corridor floater Grid in order to work out third-party system charged to users of the system. A corridor floater – also known as a range note, transportation charges. Cox-Ross-Rubenstein model fairway note or accrual note – is a structured Covariance An option-pricing model developed by John note paying an above-market rate for each day Cost-based rates A measurement of the relationship between Cox, Stephen Ross and that the underlying spot rate stays within a specified A rate-making concept used for the design and two variables. The arithmetic mean of the can be used to address factors not included in range (the accrual corridor). This higher yield development of rate schedules to ensure that products of the deviations of corresponding the Black-Scholes Model, such as early exercise. is achieved by effectively selling an embedded the filed rate schedules recover only the cost of values of two quantitative variables from their corridor option. The corridor may be reset on providing the service. respective means. Cracking given dates, either by the buyer or according to A refining technique that uses high pressures and the prevailing value of the . Cost, insurance and freight (CIF) Covariance matrix temperatures to crack heavy hydrocarbons into If the underlying trades outside the corridor, A CIF shipping cost means the cost of cargo, A square, symmetrical matrix in which the lighter products. This process is more advanced the investor receives no interest for that day. insurance and travel/freight to a named rows and columns are variables, and the entries than the simple distillation of crude oil. Alternatively, the instrument may be knocked destination are all included in the price. are covariances. The diagonal elements (the out altogether – this is a barrier floater or covariance between a variable and itself) will Crack spread knock-out range note. The holder will therefore Cost-of-carry equal the variances. A calculation of the worth of a barrel of crude benefit in stable market periods when volatility The cost-of-carry is the difference between oil in terms of the value of its refined products, is low and the underlying is more likely to stay the cost of financing an asset and the interest Covariant options such as gasoline and heating oil. Crack spreads within the corridor. received on that asset. If the financing cost is Options that give the holder the choice of may be based on a variety of refinery models lower than the interest, the asset is said to have a delivering power in a variety of forms – for and also depend on the type of crude input. Corridor option positive cost-of-carry; if higher, the cost-of-carry example, electricity, natural gas or fuel oil. They are usually expressed in dollars and cents The holder of a corridor option receives a is negative. per barrel of crude. coupon at maturity, the magnitude of which Covered option To calculate the spread, the cents-per-gallon depends on the behaviour of a specified spot Counterparty A option is one whereby the writer product prices are multiplied by 42 (the number NOTrate during the lifetimeFOR of the corridor. REPRODUCTION For A participant in a physical or financial contract. NOTowns the underlying FOR asset on which theREPRODUCTION option of gallons per barrel) and subtracted from the each day on which the spot rate (typically an is written. Generally, a covered call would only crude oil price. For example, when heating official fixing rate) remains within the chosen be written if the writer believed volatility to be oil futures cost $0.60 per gallon and Nymex spot range (the accrual corridor), the holder overpriced in the market – the lower the volatility, division light, sweet crude oil is priced at $22 a accrues one day’s worth of coupon interest. the less premium the writer gains in return for barrel, the heating oil crack spread in dollars per A variation is the knock-out corridor option. giving up their upside in the underlying. barrel = $0.60 x 42 = $25.20 – $22 = $3.20.

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Credit default swap (CDS) Credit risk Critical energy infrastructure Cumulative probability distribution function A risk management product that allows the Credit risk, or default risk, is the risk that a information (CEII) The cumulative distribution function of a random transfer of third-party credit risk from one party financial loss will be incurred if a counterparty Information regarding proposed or existing variable is the chance that the random variable is to another. In case of default, the insurer must to a (derivatives) transaction does not fulfil its critical infrastructure (physical or virtual) less than or equal to x, as a function of x. buy the defaulted asset from the insured and financial obligations in a timely manner. It is that relates to the production, generation, must pay the insured the remaining interest and therefore a function of the following: the value transmission or distribution of energy; is Cushion gas principal on the debt. of the position exposed to default (the credit potentially useful to anyone planning an The minimum volume of gas required in or credit risk exposure); the proportion of this attack on critical infrastructure; is exempt an underground storage reservoir to provide value that would be recovered in the event of a from mandatory disclosure under the Freedom the necessary pressure to deliver working gas Credit derivatives’ payouts depend in some default; and the probability of default. of Information Act; and provides other critical volumes to customers. Known as ‘pack the line’ way on the creditworthiness of an organisation Credit risk is also used loosely to mean the information beyond the location of the or linepack gas when related to pipelines. (which could be a sovereign state, a government probability of default, regardless of the value that critical infrastructure. body, a financial firm or a corporate). This stands to be lost. Cylinder creditworthiness is gauged by objective financial H see also Cross default A cylinder, also known as a range forward or criteria or a third-party evaluation from a A cross default is a provision within a or , is the simultaneous purchase of an recognised credit rating agency, such as Moody’s Credit value-at-risk (CVaR) swap contract stating that any default on another out-of-the-money put option and sale of an out- Investors Service or Standard & Poor’s. The CVaR of a portfolio is the worst loss loan or swap will be considered a default on of-the-money call option at different strike prices. Credit derivatives might not appear to have expected to be suffered due to counterparty the original contract. It is designed to protect The buyer can hedge its downside at reduced an underlying in the conventional sense. But it default over a given period of time with a creditors or counterparties from favouring cost, since the purchase of the put is partly is often argued that they are based on the cost given probability. The time period is known another credit. financed by the sale of the call, but at the cost of of a credit event or, equivalently, the premium as the holding period and the probability is relinquishing any upside beyond the higher strike. that would have to be paid to transfer the credit known as the confidence interval. CVaR is not Cross subsidisation risk of a given transaction to a third party. Most an estimate of the worst possible loss, but the Where certain customers or customer groups are importantly, these derivatives unbundle credit risk largest likely loss. subsidised by one party or group that is required from other risks. For example, the holder of a For example, a company might estimate its to pay a disproportionate share of the service floating-rate note issue can separate the credit risk CVaR over 10 days to be $100 million with a costs. In the UK, a principle whereby utilities are D (that the issuer will default) from the interest rate confidence interval of 95%. This would mean not allowed to use profits or debt from their core risk (that the coupon will fall). there is a one-in-20 (5%) chance of a loss larger regulated business for other non-regulated activities. Daily balancing There are two main types of credit derivative. than $100 million in the next 10 days. Balancing, on a day-by-day basis, the amount of The first, which includes credit default swaps H see also value-at-risk Crude oil gas a shipper puts into a pipeline system. and put options, activates in the event of a A full-ranging hydrocarbon mixture produced credit event, such as a default or downgrade of Critical day option from a reservoir after any associated gas has been Daily call option debt. A second type of credit derivative is the An option structure used for removed. Among the most commonly traded Allows a buyer of natural gas to take additional forward or option. The underlying transactions where the option payoff is based crudes are the North Sea’s Brent blend, the US’s volumes on one day’s notice. for these contracts is the spread between two on defined critical conditions being met for a West Texas Intermediate and UAE’s Dubai. otherwise identical securities, which depends specified number of days. Daily contract quantity (DCQ) only on the creditworthiness of the issuer. Swaps Cubic foot In a buyer’s nomination contract, this is the under which the total rate of return on an index One of the standards used to measure a volume average amount the buyer can have in its daily is swapped for some reference rate are sometimes of gas. nominations. The maximum rate at which NOTalso referred to asFOR credit derivatives. REPRODUCTION NOTH see also conversion FOR factors REPRODUCTIONthe buyer can ask the seller to deliver (see delivery capacity) is a function of the DCQ and Credit-linked note Cumulative degree days the swing. A similar rule exists in a seller’s A credit-linked note – also known as a credit The sum of heating degree days or cooling nomination contract, where it is called the default note – is created by the securitisation of degree days over a specified period. estimated daily contract quantity. a .

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Daily earnings-at-risk Day-ahead market Degree day Delivery month A one-day value-at-risk calculation, typically with The market trading for the day before the A measure of the variation of one day’s The month in which a futures contract matures a 95% confidence level over a 24-hour period. operating day. temperature against a standard reference and can be settled by physical delivery. Also temperature, typically 65° Fahrenheit (18° known as the contract month. Daily metered sites DCQ Celsius). Degree days are used as a basis for Supply points/sites with meters that read natural H see daily contract quantity temperature-related weather derivative deals. Delta gas volume either on a continuous or daily basis. There are both cooling degree days (CDDs) Option risk parameter that measures the Indicate the daily volume consumption needed Deepwater port and heating degree days (HDDs). For example, sensitivity of an option price to changes in the for daily balancing. The sites are at large input An offshore terminal for liquefied natural gas a firm takes out a 30-day CDD swap with a price of its underlying instrument. and offtake points on a gas system, typically for (LNG) or energy product loading/unloading, or reference temperature of 65°F, and the average large industrial gas end-users. used to describe a seaport that can accommodate temperature on each day is 70°F. The company Delta hedging a fully loaded Panamax-class ship. For LNG is then due 150 (30 x 5) degree days multiplied An option is delta hedged when a position Daisy chain operations, a deepwater port is a connection to by the sum of money agreed for each degree has been taken in the underlying that matches Term sometimes used for the paper chain an ocean floor natural gas pipeline using a turret- day. If the firm had taken out an HDD swap, it its delta. Such a hedge is only effective formed by the passing of a 15-day Brent cargo – loading buoy that serves as the LNG tanker’s would have owed the same amount of money. instantaneously, because the option’s delta is that is, 15 working days ahead of its loading mooring. Deepwater ports may also be considered itself altered by changes in the price of the date – from the equity holder through a as offshore structures used as a port or terminal for Deliverability underlying, interest rates, the option’s volatility sequence of deals. loading/unloading other energy products, such as The rate at which gas can be supplied from and time to expiry. A delta hedge must thus be H see also dated Brent, five o’clocking the Louisiana Offshore Oil Port (Loop). a reservoir – such as salt cavity storage – in a rebalanced continuously to be effective. H See also Loop given period. In a salt cavity storage facility, for H see also dynamic replication Dark spread example, the rate would depend on a number The spread between the fuel and power price Debt trigger of factors, including reservoir pressure, reservoir Delta neutral for a generator. The term spark spread is An event such as a credit rating downgrade that rock characteristics and withdrawal facilities A position for an options portfolio such that the used for gas-fired and dark spread is used for triggers further guarantee requirements on a such as pipeline capacity. The term is also used overall delta of the portfolio is zero. coal-fired generation. Like a spark spread, the loan or swap contract. for the volume of gas that a field, pipeline, well, measure of the fuel efficiency of the conversion storage or distribution system can supply in a Demand charge process is in generation. Default risk single 24-hour period. H see capacity charge H see also spark spread H see credit risk Delivery capacity Demand day Dashboard Deferred month The maximum rate at which a natural gas buyer The level of demand over a 24-hour period. In risk management, trading and financial H see back month can request the seller to deliver gas (other than applications, a consolidated report and/or excess gas) into the pipeline and which the Demand-side management graphical display highlighting key financial Deferred swap seller has a firm obligation to deliver. In peak- Activities carried out to control the level and results and control metrics, such as current and A swap under which the payments are deferred supply contracts, there may be a charge payable type of demand for electricity. trending level of value-at-risk, current trading for a specified period, usually for tax or in respect of the available delivery capacity. positions against established limits and daily accounting reasons. Not to be confused with a Demurrage mark-to-market gains and losses. forward swap, where the entire swap is delayed. Delivery facility operators The cost, or delay period resulting in the cost, H see also forward swap (UK) Companies that operate the natural gas charged when a vessel fails to unload or load Dated Brent processing facilities at gas terminals before the within the allotted time period, or laytime, NOTA term for a physical FOR cargo of Brent blendREPRODUCTION NOTgas is passed on eitherFOR into storage orREPRODUCTION to the provided by contract. A liquidating damages charge crude that has received its loading date range. national transmission system. for contract breach for detention of the ship. This occurs 15 days ahead of loading (not including weekends and holidays). Deregulation H see also Brent blend crude oil, daisy chain The halting or reduction of government regulations.

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Derivative DIG Displacement Diurnal storage A financial instrument derived from a cash The Financial Accounting Standards Board’s Where natural gas is input into a pipeline system Storage located close to all gas demand centres market commodity, futures contract or other (FASB’s) Derivatives Implementation Group, at one end and the same amount of is delivered that is used to meet the daily peaks in demand. financial instrument. Derivatives can be traded a task force that was created by the FASB in at another point, although the gas may not have Such storage is provided in the form of gas on regulated exchange markets or over-the- 1998 concurrent with their issuance of FASB been transported between the two points. holders and line-packing. counter. For example, energy futures contracts Statement No. 133 (FAS 133), Accounting for are derivatives of physical commodities, Derivative Instruments and Hedging Activities, Distillate oil Diversion and options on futures are derivatives of to assist the FASB in providing guidance on Any distilled product of crude oil. A light In the context of energy markets, generally futures contracts. questions that companies would face when they petroleum product used for home heating and refers to the diversion of cargoes from the began implementing FAS 133. most machinery. original intended destination as may be allowed Derivatives clearing organisation (DCO) under contract provisions, in order to maximise A , clearing association, clearing Digital option Distillates price arbitrage opportunities. corporation or similar entity that enables each Digital – or binary – options pay either a fixed Oil products obtained by distillation, including party to a transaction to substitute the credit sum or zero depending on whether the payoff gases, gasoline, naphthas, jet fuel, gasoil and waxy Divestiture of the DCO for the credit of the parties; to condition is satisfied – for example, cash-or- distillates. Atmospheric distillates boil at around The process of requiring monopolistic utilities arrange or provide, on a multilateral basis, for the nothing options and asset-or-nothing options. 370° Celsius, and vacuum distillates at between to spin off one segment of their business. Done settlement or netting of obligations; or to provide H see also digital swap 370° and 525°C. to ensure that uncompetitive advantages created clearing services or arrangements that mutualise by former government actions are removed, or transfer credit risk among participants. Digital swap Distillation so that competition can develop. A utility The fixed leg of a digital swap is only paid on The simple refining of oil by boiling. with generation, transmission and distribution Designated contract market (DCM) each settlement date if the underlying has fulfilled facilities, for example, might be forced to Boards of trade (or exchanges) that operate certain conditions over the period since the Distributed generation sell off its generation. Also known as vertical under the regulatory oversight of the previous settlement date. The premium for such a A distributed generation system is characterised disaggregation. Commodity Futures Trading Commission. swap is paid in instalments at each payment date. by a number of smaller, interlinked generators, DCMs are like traditional futures exchanges in H see also digital option rather than a single central generator. Dodd-Frank that they may allow access to their facilities by The Wall Street Reform and Consumer Protection all types of traders, including retail customers. Direct current (DC) Distribution Act, introduced by Barney Frank and Chris The unidirectional flow of electric charge. 1) The probability distribution of a variable Dodd, was enacted on July 21, 2010. Diesel High-voltage DC is a technique often used for describes the probability of the variable attaining The main focus for energy market participants A middle distillate fuel used in diesel engines. undersea cables connecting different countries. a certain value. The distribution assumed by an is Title VII of the Act (of which there are 16 Power transmitted in this way suffers less reactive option pricing model is crucial to that model’s titles), which aims to regulate the swaps market. Difference option power loss than an alternating current line. It predictions, since it determines the likelihood of While the legislation set out a broad structure An option that pays the price difference also allows connection of two asynchronous the option being exercised. for the new regulatory regime, the Commodity between two assets. The strike price provides the alternating current networks. 2) The delivery of electricity to the retail Futures Trading Commission (CFTC) and initial reference point for valuing the option. A customer’s home or business from the main grid Securities and Exchange Commission are buyer’s profit or loss will depend on how the Dispatchable generation through low-voltage distribution lines. Low responsible for filling out the structure and current price differential between the two assets Generation available physically or contractually voltages range from 2,300 to 69,000 volts. are in the process of doing this via a series of compares with the differential when the option to respond to changes in system demand or to 3) The delivery of gas from the city or plant to proposed rule-makings that are then made was launched. respond to transmission security constraints. the customer. available for public comment. As of March NOT FOR REPRODUCTION NOTH see also transmission FOR facility REPRODUCTION2011, no final rule-makings have been made by Differential swap Dispersion either regulator. A quanto swap. The distribution pattern of measurements. Diurnal matching The main provisions in Title VII that will The Standard Deviation is the most common The daily balancing of the difference affect the energy sector include mandated measure of dispersion. between a shipper’s gas input volume and exchange trading, clearing and reporting for its customers’ offtake. certain types of swaps, the registration and

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regulation of dealers and major end-users of Downstream EITF swaps, and the creation of new market entities Activities in the oil and natural gas industry from The Emerging Issues Task Force, a unit of the such as clearing organisations, data repositories a refinery onwards – for example, the distribution Financial Accounting Foundation that addresses and exchanges. The CFTC has also been and marketing of hydrocarbon products. E accounting issues not yet addressed by a given the authority to set position limits for H see also upstream ECC published Financial Accounting Standards Board certain types of commodities (including some H see European Commodity Clearing Statement of Financial Accounting Standards. energy commodities such as oil and natural Dry dock gas) to protect against excessive speculation and A large dock in the form of a basin, which can ECX EIA prevent individual entities building up large be flooded to float in vessels and then drained to European Climate Exchange. H see Energy Information Administration concentrated market positions. create a dry area around the vessel. It is used for building or repairing a ship below its water line. E&P El Niño DoE Exploration and production. A periodic warming of the tropical Pacific (US) Department of Energy. Dry gas Ocean that affects weather around the world. Gas with a low liquid content, usually below two EDCQ Typical consequences of El Niño include Domestic market gallons per 1,000 cubic feet. This may happen (Gas) Estimated daily contract quantity. increased rainfall in the southern US and The section of the energy market that covers naturally, as in most of the fields in the southern drought in the western Pacific. Winter energy requirements for domestic premises. North Sea, or the water content may be reduced Edison Electric Institute (EEI) temperatures in the north-central states of by a dehydration process. Also known as lean gas. Formed in 1993, The Washington, DC-based the US are typically warmer than normal in Done H see also wet gas EEI is an association of US shareholder-owned El Niño years and cooler than normal in the Term used to indicate that a deal has been electricity companies, international affiliates and southeast and southwest of the country. completed. For example, a broker might tell a DTI industry associates worldwide. In 2008, its US However, its effects outside the tropical Pacific trader that he is ‘done’, meaning his buy/sell (UK) Department of Trade and Industry. members served more than 95% of customers in are unpredictable and almost any definition requirements have been matched precisely. the shareholder-owned segment of the industry would be disputed by meteorologists. The Dual-firing and generated almost 70% of the electricity warmest and coldest winters in the northeast Double-down Where two different fuels – for example, gas and produced by US power utilities in total. US since 1950 have both occurred during El A swap with an that permits oil – can be used to generate energy in one Niño periods. The name of the phenomenon the writer of the swap to halve the agreed piece of equipment. EEX derives from the fact that it tends to appear volume once, and once only, at or before an H see also co-firing H see European Energy Exchange around Christmas – El Niño means ‘little boy’ agreed date. In return, the buyer of the swap in Spanish, the name commonly given to the obtains a more favourable price. Dubai EFP infant Christ. A benchmark crude produced in Dubai, one of H see exchange of futures for physicals A 1997/1998 El Niño winter gave a boost to Double-up the United Arab Emirates. Dubai is commonly the weather by prompting The exact reverse of double-down, with the used as a reference price for Asia-Pacific. EFS energy companies to hedge against mild winter writer of the swap having the option to double H see exchange of futures for swaps weather that would decrease energy demand. the agreed volume. Dynamic hedging H see delta hedging EFET Master Agreement Electric power trading day Dow Jones A standardised master agreement developed For trading purposes in designating hours A leading provider of global business news and Dynamic replication by the European Federation of Energy Traders traded, the 24-hour period beginning at information services. Among other publications, Replication of an option payout by buying for the delivery and acceptance of electricity, midnight and ending the following midnight. NOTits consumer media FOR group publishes TheREPRODUCTION Wall or selling the underlying (or futures, where NOTproviding a similar FOR structure to the InternationalREPRODUCTION Street Journal and Barron’s. cheaper) in proportion to an option’s delta. Swaps and Derivatives Association by containing Dynamic replicators are exposed to increases in a General Agreement and Election Sheet for Downside risk volatility, which may increase the costs of the agreed revisions to the General Agreement. H see upside/downside risk necessary hedge. H see also delta hedging, static replication

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Electric utility Eligible contract participant Eminent domain End-user clearing exception An entity engaged in the production and/ An entity that is permitted to engage in The power the government has under the An elective exception from the Commodity or distribution of electricity for public use, transactions – such as trading on a derivatives Takings Clause in the US Constitution to obtain Futures Trading Commission’s (CFTC’s) including investor-owned, co-operative-owned, transaction execution facility – not generally the property of an individual even without the mandatory clearing requirement if one party and government-owned (municipal systems, available to non-eligible contract participants person’s full consent in exchange for fair market to the swap is not a financial entity, is using federal agencies, state projects and power based on its regulated status or amount of assets. value. The government most often exercises this swaps to hedge or mitigate commercial risk and districts) utilities. These entities include financial institutions, power to build public enterprises such as roads, notifies the CFTC, in a manner set forth by it, H see also power marketer insurance companies, commodity pools and schools or utilities installations. how it generally meets its financial obligations wealthy individuals. associated with entering into non-cleared swaps. Electric Utilities Industry Law Emissions credits A law that was amended in 1995 to open the Eligible commercial entity The instruments created by regulations in Energimarknadsinpektionen/ Japanese electricity market to competition. A category of contract participants who are the US market to encourage market-driven Energy Markets Inspectorate (EI) Implementation of the March 2000 stage, eligible to trade in certain commodity markets reductions of pollution. The Swedish regulatory authority that works opened up the country’s high-voltage sector – in the US, or other persons the Commodity for efficient energy markets through supervision 30% of the electricity market – to competition. Futures Trading Commission may deem Emission reduction units (ERUs) and monitoring of markets. appropriate by rule, regulation or order. Represents one tonne of CO2 equivalent Electricity reduction of greenhouse gas emissions, Energy Brokers Association A brokered over-the-counter market in the UK Embedded costs particularly as achieved through a joint A Washington, DC-based initiative launched for short- to medium-term electricity derivative The cost of all the facilities in an electricity or implementation project. ERUs can be used as in 2002 with the aim of more clearly defining instruments, of which the most widely used is natural gas supply system. the unit of trade in greenhouse gas emissions the role of over-the-counter brokers in energy the electricity forward agreement. trading systems, or to meet an Annex B Party’s markets and of recommending and introducing Embedded derivatives emission commitment. best processes throughout the industry. Electronic bulletin board Within a US accounting context of FAS 133, A system whereby US gas industry participants, portions of contracts that meet the definition Emissions trading Energy Information Administration (EIA) such as pipeline companies, advise on their of a derivative when the entire non-derivative Emissions trading, as set out in Article 17 of A US government agency that produces reports transport, storage and delivery capacity contract cannot be considered a financial the Kyoto Protocol, allows countries that have on US energy supply and demand, most notably availability. Under Federal Energy Regulatory instruments derivative. emission units to spare - emissions permitted a weekly report detailing crude and product Commission rules, all pipelines are obliged to H see also FAS 133 them but not ‘used’ - to sell this excess capacity inventories in various areas of the US. The report post information on electronic bulletin boards in to countries that are over their targets. covers US refinery throughput, as well as crude order to allow open access. Embedded option Thus, a new commodity was created in the and product imports and exports. Information is An option, often an , form of emission reductions or removals. Since also provided on natural gas and electricity. Electronic trading embedded in a debt instrument that affects carbon dioxide is the principal greenhouse H see also American Petroleum Institute Internet-based trading on a real-time basis. its redemption. Embedded options are usually, gas, people speak simply of trading in carbon. but not always, interest rate options; some are Carbon is now tracked and traded like any Enterprise-wide risk management Electronic trading facility linked to the price of an equity index (for other commodity. This is known as the An integrated approach to risk management. A trading facility that operates through an example, Nikkei 225 puts embedded in Nikkei- carbon market. For example, defining a framework to identify electronic or telecommunications network linked bonds) or a commodity (usually gold, and anticipate all kinds of risk that can affect and maintains an automated audit trail of but sometimes oil). Embedded options may be End-user an organisation. transactions on the facility. embedded in physical commodity contracts or A true consumer of a product or service. NOT FOR REPRODUCTIONcommodity derivatives such as extendible swaps. NOT FOR REPRODUCTIONEntry cost (UK gas) Tariff for using the UK’s national transmission system.

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Environmental assessment (EA) European Commodity Clearing AG (ECC) European Federation of Energy Traders (EFET) European Union (EU) An EA is prepared to assist in determining if ECC operates a clearing house for energy- EFET is a group of more than 90 energy The EU is an organisation of 27 Member there will be significant impacts of a project related commodities and their derivatives. trading companies from 23 European countries States designed to promote economic and proposal. An agency will have to prepare a more Currently, ECC provides clearing services dedicated to improving conditions for energy social progress. Through its executive body, the rigorous environmental impact statement if the for contracts traded on the European Energy trading in Europe and providing an exchange European Commission, the EU makes policy study finds that significant impacts will result. Exchange, the European Energy Derivatives for non-commercially sensitive information that is legally binding in its Member States. Exchange and the Powernext SA, as well as between organisations and members of the Environmental impact statement (EIS) for over-the-counter trades registered via these developing pan-European energy industry. European Union Electricity Directive The US National Environmental Policy Act of 1969 exchanges. ECC is supervised by the German EFET is complementary to existing industry The European Parliament and Council Directive requires all federal agencies to issue a statement Federal Financial Supervisory Authority. organisations in European organisations as it is 96/92/EC concerning common rules for the for any major federal action that may significantly Founded in 2006, ECC currently offers clearing solely dedicated to energy trading issues. internal market in electricity. Its aim is to ensure affect the quality of the environment. An EIS is a services for the following commodities: German, the free movement of electricity by defining more detailed evaluation than the enviromental French, Austrian, Swiss, Belgian and Dutch European Regulators’ Group for common rules for production, transmission and assessment and requires the agency to evaluate power, emissions allowances, coal and natural gas. Electricity and Gas (ERGEG) distribution across EU Member States. both the proposed action and alternatives. ERGEG is an advisory group of independent Under the terms of the directive, which came European Energy Exchange (EEX) national regulatory authorities. ERGEG was into effect in 1999, customers using 40GWh of EPA The EEX was founded in August 2000 and established on 11 November, 2003, pursuant electricity a year – about 25% of the market – The US Environmental Protection Agency. merged with its rival, the Leipzig Power to Directive 2003/796/EC, to assist the were able to choose their supplier. From July Exchange, in early 2002. Today, with more than Commodity Futures Trading Commission in 2007, at the latest, consumers in all Member ERCOT 200 trading participants from 19 countries, consolidating the internal market for electricity States will be able to freely choose their gas and Electric Reliability Council of Texas – a North the energy exchange has become the most and gas. Its members are the heads of the electricity suppliers. American Electric Reliability Council for the important energy exchange in continental national energy regulatory authorities in the 27 Texas Interconnection. Europe. EEX offers futures and spot markets in EU Member States. European Union Natural Gas Directive electricity and, in March 2005, began trading The European Parliament and Council Directive Ethanol and settlement of CO2 emissions allowances. In European-style option 98/30/EC concerning common rules for the Ethyl alcohol (CH3CH2OH), often derived from 2008 the merger of EEX and Powernext created An option that may only be exercised on its internal market in natural gas. Its aim is to create corn, that can be blended with gasoline to make a common spot and futures market in power. expiration date. a single Europe-wide gas market by reducing the fuel burn more cleanly. Several US states H see also Powernext H see American-style option barriers to trade and encouraging new entrants are phasing-in the use of ethanol in gasoline into the market. to replace methyl tertiary butyl ether, which European Emissions Allowances (EUA) European Transmission System Under the terms of the directive, which came has been blamed for water pollution incidents. Represents a permit to emit one tonne of Operators (ETSO) into force in August 2000, customers using 25 Ethanol may also be referred to as grain alcohol. carbon under the European Union Emissions Was created following the development of the million cubic metres a year (cm/y) – about Trading System. Since one EU Allowance Unit Internal Electricity Market for the EU, as an 25% of the market – are able to choose their EUA of one tonne of CO2, or ‘EUA’, is equivalent association to support EU-wide harmonisation supplier. The threshold fell to 15 million cm/y – European Union Allowances – nationally to one ‘assigned amount unit’ of CO2 defined of network access and conditions for usage, covering 28% of the market – in 2003. secured rights to emit a certain amount of under Kyoto, it is possible to trade EAUs and especially for cross-border electricity trading. grehouse gases. 1 EUA = 1 tonne CO2 United Nations Framework Convention on The networks represented by ETSO supply EXAA Climate Change-validated Certified Emission more than 490 million people with electric Energy Exchange Austria, the Austrian energy Eurelectric Reductions on a one-to-one basis within the energy. The consumption of electric energy exchange that operates an electronic platform NOTIs the association FORof the electricity industry REPRODUCTION same system. NOTamounts to approx. FOR 3,200TWh per year.REPRODUCTION The for trading the Austrian spot market for in Europe, including electricity producers, length of high-voltage (400kV and 220kV) lines electricity. EXAA plans to add over-the-counter suppliers, traders and distributors. The current covered by ETSO exceeds 290,000km. clearing for electricity contracts and futures association was created in December 1999 as trading. a result of a merger in December 1999 of the sister sector bodies Unipede and Eurelectric.

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Excess cargo Exchange-traded option Extendible swap FEED contracts As used in the liquefied natural gas (LNG) An option traded and cleared on an organised A swap with an embedded option constructed ‘Front-end engineering and design, typically market, the cargoes in excess of long-term securities or derivatives exchange. Such options on a similar principle to a double-up swap. An referring to planning and design (with contracted quantities of LNG, which are are usually, but not always, standardised by strike, extendible swap allows the provider to extend defined groups of activities or segments) in typically either offered to existing long- maturity and underlying. the swap, at the end of the agreed period, for a the early stage of a project, especially for the term buyers or alternatively auctioned in the further predetermined period. process industry. spot market. Exercise The process of converting an options contract Extrinsic value Feedstocks Excess gas into a futures or physical position. The amount of money the buyer of an option The supply of crude products, natural gas, A natural gas buyer may ask the seller to deliver is willing to pay in anticipation that a change chemicals or raw materials used in a refinery, above the delivery capacity rate. The seller does Exempt commercial market in the underlying futures price will cause the liquefied natural gas liquefaction plant, or not have to do so but, if it does, the buyer will An electronic trading facility that trades exempt option to increase in value. Also known as petrochemical plant for processing into a pay a premium over the main contract price. commodities on a principal-to-principal time value. finished output product or products. basis solely between persons that are eligible Exchange commercial entities. FERC Any trading arena where commodities and/or H see Federal Energy Regulatory Commission securities are bought and sold – for example, Exercise price the Chicago Mercantile Exchange or the H see strike price F FERC order 636 IntercontinentalExchange. Fair value A Federal Energy Regulatory Commission Exit charge In the pricing of financial instruments, the value (FERC) order issued in 1992 to restructure Exchange of futures for physicals (EFP) (UK) Tariff for exiting the national transmission determined by mathematical modelling of the the US gas pipeline industry. It relaxed service The conversion of a futures position into a system at a specified exit point and for a certain instruments’ value. requirements on pipeline firms and gave physical position via simultaneous buy/sell volume of gas. Also used as a defined term in US accounting customers greater flexibility as to whom they transactions. Also referred to as exchange of standards as ‘fair-value accounting’ and ‘fair- could buy from by separating gas sales from futures for product. value hedges’ as in FAS 133. A fair-value hedge transportation. This ‘unbundling’ involved the Any option whose payout structure is more is a hedge of the exposure to changes in the extension of transportation to include storage Exchange of futures for swaps (EFS) complicated than a plain-vanilla put or call fair value of a recognised asset or liability, or of and allowed end-users, with firm transport The conversion of a futures position into a swaps option. Examples of exotic options include an unrecognised firm commitment, which are contracts, to sell unused capacity. FERC has position via simultaneous buy/sell transactions. Asian options, barrier options, digital options attributable to a particular risk. issued three orders related to FERC order 636: and spread options. numbers 636-A, 636-B, and 636-C. Exchange option H see also option, vanilla options FAS 133 An option giving the buyer the right to H see Financial Accounting Standards Board Statement 133 FERC order 888 exchange one asset for another. For example, the Expiration date A Federal Energy Regulatory Commission purchaser of a euro-oil exchange option would The last day on which an option may Fat tails (FERC) order issued in 1996 to restructure the have the right to exchange a certain amount of be exercised. On a distribution curve, a fat-tailed distribution US wholesale electricity industry. It required all euros for a certain number of barrels of oil. has a greater-than-normal chance of a big utilities that owned transmission lines to provide H see also integrated hedge Ex-ship positive or negative realisation. open-access, non-discriminatory service for A shipping delivery provision whereby cargo all wholesale transactions (including their own Exchange rate agreement responsibility and risk resides with the shipper Federal Energy Regulatory Commission (FERC) wholesale transactions) and allowed utilities to NOTA synthetic agreement FOR for forward exchange, REPRODUCTION until the ship has arrived at designated port and NOTThe US government FOR body that regulates REPRODUCTION US seek recovery of the stranded costs associated whereby the two counterparties agree a rate cargo is available for delivery. interstate energy markets. with providing open access. FERC has issued based on forward foreign exchange rates. Unlike three orders related to FERC order 888: Order a forward exchange agreement, it is settled No. 888-A, 888-B and 888-C. Each clarified without reference to the spot rate. FERC order 888 but reaffirmed the basic determinations of FERC order 888.

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FERC order 2000 Firm energy Floor Forward contract A Federal Energy Regulatory Commission Electricity transmission service offered to 1) The main trading area of an exchange. A private contract between a buyer and order issued in February 2000 that cleared customers under a filed rate schedule that 2) A supply contract between a buyer and seller seller, whereby the buyer is obligated to take the way for the formation of regional anticipates no planned interruption. of a commodity, whereby the seller is assured delivery and the seller is obligated to provide transmission organisations. that it will receive at least some minimum price. delivery of a fixed amount of a commodity at Firm service This type of contract is analogous to a put a predetermined price on a specified future FCM Gas or electricity sales that are guaranteed not option, which gives the holder the right to sell date. Payment in full is due at the time of, H see Futures Commission Merchant to be interrupted. the underlying at a predetermined price. or following, delivery. In contrast to futures H see also interruptible service, non-firm service contracts, forward contracts are not standardised Financial Accounting Standards Board (FASB) Floor broker or transferable. Private-sector organisation responsible for Firm (uninterrupted) A person with exchange trading privileges establishing standards of accounting and financial Natural gas for which the full price has been who – in any pit, ring, post or other place Forward freight agreement (FFA) reporting in the US. paid on the understanding it will be delivered provided by an exchange for the meeting of FFAs are derivatives instruments used to hedge continually through the contract period. brokers – executes client orders for the purchase risk in the tanker freight sector. Financial Accounting Standards Board H see also interruptible service or sale of any commodity for future delivery, Statement 133 (FAS 133) security futures product or swap. Forward price curve FAS 133 obliges US firms to put all financial Five o’clocking A list or graph of the future value of a derivative instruments that are not used to Twenty-one days before a cargo of Brent blend Floor trader commodity or financial instrument over time. hedge exposure on the balance sheet at market crude oil loads at the Sullom Voe terminal, A person with exchange trading privileges value. Companies, therefore, disclose unrealised the details of the cargo are passed through the who – in any pit, ring, post or other place (FRA) gains and losses on derivatives, rather than paper chains. If the cargo has not been sold by provided by an exchange for the meeting of An over-the-counter forward contract on accounting for them only at maturity. 17:00 local UK time, then the last participant traders – purchases or sells, solely for their own a short-term interest rate. The buyer of an to receive a call with the cargo details owns account, any commodity for future delivery, FRA commits to pay a fixed rate of interest Financial entity the physical cargo and has been ‘five o’clocked’. security futures product or swap. on some notional amount that is never Includes any of the following: (i) a swap dealer; Normally this is seen as a bearish sign, as actually exchanged. The seller of an FRA (ii) a security-based swap dealer; (iii) a major it usually happens in a market with low FOB agrees notionally to lend a sum of money to a swap participant; (iv) a major security-based swap crude demand. H see free-on-board borrower. FRAs can be used either to hedge participant; (v) a commodity pool; (vi) a private H see also daisy chain or to speculate on future fund; (vii) an employee benefit plan; or (viii) a FOD changes in interest rates. person predominantly engaged in activities in the Flexibility bid H see fuel oil domestique business of banking or financial in nature. In the gas market, where the system needs to Forward start option buy or sell gas to keep it in balance, a shipper Force majeure An option that gives the purchaser the right to Financial products mark-up language (FPML) may put in a flexibility bid. The shipper specifies A contract clause that allows the supplier to receive, after a specified time, a standard put or FPML is a standardised language designed for whether it is a buy or sell, the date or dates to forego his obligation to supply in extreme call option. The option’s strike price is set at the sharing information on, and dealing in, swaps, which it applies, the amount of gas, the calorific circumstances, such as a political crisis, war or time the option is activated rather than when it is derivatives and structured products across value of the input gas, how quickly it could strikes that disturb production. It also applies purchased and is usually set with reference to the software and hardware systems. be implemented, how and where it would be to a buyer that is unable to take delivery of prevailing spot rate when the option is activated. implemented and the price. product – for example, a refiner whose refinery H see also chooser option Firm capacity is shut down following a fire or disaster. NOTAn amount of naturalFOR gas in a buyer’s REPRODUCTIONcontract Floating liquefaction NOT FOR REPRODUCTIONForward swap that is guaranteed not to be interrupted, or a Technology used for new types of liquefied A swap in which payments are fixed before liquefied natural gas (LNG) terminal access natural gas facilities and vessels that have the start date – used when one party expects capacity contractually guaranteed by the on-board liquefaction plants. Such technology market rates to rise soon, but will not need terminal operator or guaranteed capacity by provides an alternative for developing otherwise funds until later. LNG shippers or sellers. stranded natural gas reserves. H see also deferred swap

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Fossil fuels Fuel cell Futures commission merchant usually has a declared heating value of 1,035 Buried deposits of organic materials that have A device that converts fuel energy to electrical An individual or organisation that solicits or British thermal units per cubic foot. been compressed over millions of years into energy by means of an electrochemical process. accepts orders to buy or sell futures or futures 2) North American abbreviation for gasoline. crude oil, coal or natural gas. Fuel cells chemically combine the molecules options and accepts money or other assets from of a fuel (most commonly hydrogen) and a customer in connection with such orders. Gasification FRCC an oxidiser (for example, air) to create heat They needs to be certified by the Commodities Increasing the temperature and decreasing the Florida Reliability Co-ordinating Council – a without burning, thereby reducing the thermal Futures Trading Commission. pressure of liquefied natural gas to covert it from North American Electric Reliability Council inefficiencies and pollution that characterise a liquid back to gas. within the Eastern Interconnection whose traditional means of combustion. Futures contract purpose is to ensure and enhance the reliability An agreement between two parties, one to buy Gas Industry Standards Board and adequacy of bulk electricity supply in Fuel gas and the other to sell a fixed quantity and grade A US industry forum aimed to develop and Florida now and into the future. Various gases that may be burned to produce of a commodity, security, currency index or promote standards that would lead to a seamless thermal energy, including natural gas, propane, other good at a given price on a specified date market for natural gas. The Gas Industry Free-on-board (FOB) butane, liquefied natural gas or hydrogen. in the future. Exchange-traded supply contract Standards Board was a precursor to the North Under an FOB contract, the seller provides the between a buyer and a seller, whereby the buyer American Energy Standards Board. crude oil, oil product or liquefied natural gas Fuel oil is obligated to take delivery and the seller is at a lifting installation, so that all loading costs Heavy refined distillates. Used to fuel power obligated to provide delivery of a fixed amount Gas nominations to put the commodity on board a carrier have stations and in ships and industry. The different of a commodity at a predetermined price at a In the US, nomination deadlines are where each been paid, but the buyer takes responsibility for fuel oil grades are classified according to their specified location. Futures contracts are traded pipeline has a scheduled deadline before which shipping and freight insurance. viscosity and sulphur content. exclusively on regulated exchanges and are settled shippers must book gas for the following month. H see also CIF daily based on their current value in the market. Fuel oil domestique Gasoil Freight derivatives Gasoil of a particular specification used for end- Futures option A middle distillate and form of heating oil Derivatives instruments used to hedge risk in the user central heating in France. An option on a futures contract. used primarily in heating and air-conditioning tanker freight markets. Tankers are one of the most systems. One of the most actively traded oil common means of transporting commodities such products, gasoil is the underlying in a key as oil and coal. Freight derivatives, such as swaps or Analysis of supply and demand factors that International Petroleum Exchange futures forward freight agreements, can be used to protect could influence the direction of price of a contract. In refining terms, gasoil comes ship owners against changes in freight rates. commodity. For example, electricity traders, between fuel oil and the lighter products such as using fundamental analysis, consider weather G naphtha and gasoline. In its broader definition, Frequency patterns, transmission constraints and unexpected Gamma it covers the oil products used for diesel The number of cycles per second of power plant outages to calculate the demand for The sensitivity of an option’s delta to changes in automotive fuel and jet fuel. electromagnetic waves, as measured in hertz. power and the amount of generation available in the price of the underlying futures contract. the region. Gasoline Front month H see also technical analysis Garch A light-end hydrocarbon distillate used for H see prompt month General autoregressive conditional internal combustion engines, actively traded as Fungibility heteroscedasticity. A statistically advanced futures and options contracts on Nymex. Also Front quarter A product is fungible if it can be exchanged. method for measuring time-varying volatility. known as petrol. Quarterly contract that begins at the start of the Futures contracts for the same commodity and NOTfollowing quarter. FOR REPRODUCTIONdelivery month are said to be fungible due to NOTGas FOR REPRODUCTIONGas year their standardised specifications. 1) Natural gas covers a range of gases that occur In the UK, the gas year begins at 06:00 on Front year naturally and are composed mainly of methane October 1. This is also known as the contract Typically refers to the first year of a long term, (CH4) and ethane. In the UK gas supply year, as it is when purchase contracts begin. such as that for liquefied natural gas or other industry, it refers to the gas supplied through energy products contract. the mains system (mainly CH4). North Sea gas

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Gathering lines Geothermal energy Global warming Grid Small pipelines used to transport oil or gas Energy derived from the heat of the earth’s Global warming is the progressive gradual rise An electricity transmission system. from the well to a processing facility or a core. Geothermal energy sources include of the earth’s surface temperature, thought by mainline pipeline. steam, hot water or hot rocks lying close to the many scientists to be caused by the greenhouse Grid operator earth’s surface. effect and responsible for changes in global H see system operator GCC climate patterns. (UK) Gas Consumers Council, known as German Power Index GTC energywatch. In 2008 the Welsh, Scottish and An electricity price index for the whole GME H see good till the close National Consumer Councils merged with of Germany, launched by Dow Jones in H See Gestore del Mercato Elettrico Postwatch and energywatch to form Consumer January 2001. Created through the merger Focus. of the Central European Price Index and the Good till the close (GTC) (Middle East) Gulf Co-operation Council. Electricity Index South. An order given to a futures broker that stays live until fulfilled, or until the close of the market, H GCV Gestore del Mercato Elettrico (GME) whichever is sooner. Gross calorific value. The Italian electricity market operator that was Head and shoulders H see also calorific value set up by the independent transmission system Grandfather clause A three-peak pattern resembling the ‘head and operator and operates the Italian wholesale In the US, a clause in a contract that allows shoulders’ outline of a person, which is used Gearing electricity market. GME is responsible for a prior law to take precedence over newly to chart stock and commodity price trends. The gearing of a derivative is the price issuing the electricity market rules, subject to introduced legislation. The pattern indicates the reversal of a trend. As of the underlying divided by the price of input from the electricity and gas regulator prices move down to the right shoulder, a head the derivative. This can be used for crude and approval by the Minister of Industry. GME and shoulders top is formed, meaning prices assessments of leverage and option pricing. A is also responsible for managing the Italian A measure of the sensitivity of an option’s value should be falling. A reverse head and shoulders more sophisticated measure is effective gearing electricity market to promote competition to changes in the parameters used to value it. pattern has the head at the bottom of the chart, (or lambda), which is the traditional gearing between producers, to ensure an adequate Greek measures include delta, gamma, rho, theta meaning prices should be rising. multiplied by the derivative’s delta. availability of power reserves, enforcing merit- and vega. H see also leverage order economic dispatch and managing the Heat rate Italian power exchange. It became operational in Greenhouse effect A measure of how efficiently an electricity Generating availability database 2004 and it is owned by the Italian Ministry of An increase in global temperature caused when generator converts thermal energy into The generating availability database (Gads) Finance and Economy. the earth’s atmosphere traps solar radiation. It electricity, and a key determinant of the spark collects, records and retrieves operating occurs due to the presence in the spread. More precisely, the heat rate is the information about the performance of Gielda Energii atmosphere of gases such as carbon dioxide, ratio of British thermal units of fuel consumed electricity-generating equipment. More than H see Polish Power Exchange water vapour and methane, which allow to kilowatt hours of electricity produced. 180 generating facility operators in the US and incoming sunlight to pass through, but trap Hence, the lower the heat rate, the higher the Canada voluntarily participate in Gads. Gigajoule heat radiated back from the earth’s surface. conversion efficiency. One billion joules, approximately equal to The burning of fossil fuels is thought by many Generation 948,000 British thermal units. scientists to be a major contributory cause of Heating degree day The process of producing electrical energy by the greenhouse effect. H see degree day transforming other forms of energy. The amount Gigawatt (GW) of energy produced is expressed in watt hours. One billion watts Greenfield Heavy NOT FOR REPRODUCTION NOTPreviously undeveloped FOR site considered REPRODUCTION suitable Typically crude oil with an American Petroleum Geometric return Gigawatt hours (GWh) for commercial development or industrial Institute gravity of less than 28 degrees. Log return. One billion watt hours projects, but currently in its natural state or used for agriculture. Geometric Brownian motion H see stochastic process

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Heavy fuel oil Hedge effectiveness Hertz HSFO A heavy refined distillate consisting largely of In US accounting terminology, a criteria that A unit of frequency equal to one cycle per second High-sulphur fuel oil. residues from crude oil refining that are blended must be met in order to use hedge accounting and measured by changes in cycles or state. with gasoil fractions. The heaviest grade fuel oils for US financial reporting. This provision has Hydrocarbons tend to be used in ships’ boilers, while lighter at times proven problematic in the energy Hinshaw pipeline Organic compounds consisting of hydrogen and fuel oil grades are used in industry, such as in industry where partial hedges for such exposure A pipeline that operates within a single state but carbon. They may exist as solids, liquids or gases. steel manufacture. components as basis risk are widely used. Under can receive gas from outside its state without the rules FAS 133 when testing for hedge becoming subject to the Federal Energy Hydropower Heavy-tailed distribution (fat-tailed) effectiveness, only interest rate exposures can be Regulatory Commission’s Natural Gas Act Electrical energy produced by flowing water. A A distribution in which the extreme portion broken down into their component parts. jurisdiction. hydroelectric power plant uses the movement of the distribution (the part furthest from the H see also FAS 133 of water to spin a turbine generator that median) spreads out further relative to the width Historical simulation produces electricity. of the centre (middle 50%) of the distribution Hedge fund A method of calculating value-at-risk (VaR) than is the case for the . A private pool of assets, which is often managed that uses historical data to assess the impact of Hydropower exemption For a symmetric heavy-tailed distribution, the aggressively. Hedge funds have long been active market moves on a portfolio. A current portfolio The Federal Energy Regulatory Commission probability of observing a value far from the in speculative trading on crude oil markets. is subjected to historically recorded market exempts hydropower projects from its median in either direction is greater than it movements; this is used to generate a distribution jurisdiction that are less than 5 megawatts. would be for the normal distribution. Heavy- Hedge ratio of returns on the portfolio. This distribution can tailed describes a distribution with excess kurtosis. The ratio, determined by the option’s delta, of then be used to calculate the maximum loss with Hydropower licence futures to options required to establish a position a given likelihood – that is, the VaR. The Federal Energy Regulatory Commission Hedge involving no price risk. Because historical simulation uses real data, it (FERC) issues major licences for constructing The initiation of a position in a futures or options can capture unexpected events and correlations and operating a new project or operating market intended as a temporary substitute for Heel that would not necessarily be predicted by a an existing project that generates more than the sale or purchase of the actual commodity. The small amount of liquefied natural gas theoretical model. 5 megawatts. FERC issues minor licences for For example, the sale of futures contracts in (LNG) remaining on board a vessel (or storage) projects with capability of less than 5 megawatts. anticipation of future sales of cash commodities after discharge of the regular LNG cargo, and Historical volatility FERC can also issue a re-licence, which extends as a protection against possible price declines, or is used to insulate the LNG storage tanks The annualised standard deviation of percentage the term of an existing licence. the purchase of futures contracts in anticipation and available as fuel for carrier ship. The heel changes in futures prices over a specific period. of future purchases of cash commodities as a is considered to exist both before and after An indication of past market volatility. protection against possible increasing costs. discharge, as the minimum quantity of LNG necessary to be retained in holding tanks, and Hot LNG Hedge accounting also includes LNG that is consumed en route to Liquefied natural gas with a British thermal unit Hedge accounting is the practice of deferring the discharge destination as fuel. content that is higher than the standard on US gains and losses on hedges until and Canadian pipelines, since it contains small the corresponding gain or loss in the underlying Henry Hub amounts of natural gas liquids (NGLs), and may exposure is recognised. It allows companies to The delivery point for the largest Nymex also be referred to as Rich LNG. The NGLs – incorporate the cost of hedging into the cost natural gas contract by volume. Henry Hub typically ethane, propane and butane – can be of the exposure. Gains are thereby offset against is in Erath, Louisiana, and is a large system of extracted following regasification and used as losses. This reduces the volatility of earnings. pipeline interconnects. petrochemical feedstocks. NOTH see also accrual accounting,FOR mark-to-market REPRODUCTION NOTH see also lean LNG FOR REPRODUCTION Heren ICIS Heren is a world-leading publisher of gas, Houston ship channel power and carbon market information. In 2008, A major US oil refinery centre in Texas on the ICIS, part of Reed Business Information UK, US Gulf Coast. It is also a pricing and major acquired Heren Energy (now ICIS Heren). market point for natural gas in the US.

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Independent power producer Installed capacity obligation Intermediate generation (cycling generation) A non-utility power generating company. A US term that refers to the amount of Power-generating equipment that can vary generation that meets load plus a certain its level of output in response to changes in Independent system operator (ISO) percentage or margin set using a probabilistic electricity demand. Normally operated on I (US) Entity, regulated by the Federal Energy model. The extra margin ensures reliability a daily cycle to serve on-peak loads during IAS 39 Regulatory Commission, that is responsible for during a maximum emergency. the day but not off-peak loads during nights An accounting standard, titled Financial ensuring the efficient use and reliable operation and weekends. Instruments: Recognition and Measurement, issued of the transmission grid and, in some cases, Integrated hedge by the International Accounting Standards (IAS) generation facilities. Individual ISOs cover A hedge combining more than one distinct price International Energy Agency (IEA) Committee. IAS 39 is similar, but much less either a single state (for example, the California risk. For example, crude oil is usually priced The IEA, based in Paris, is an intergovernmental complex, than the US Financial Accounting ISO) or a region (for example, the Midwest in US dollars. A producer of crude oil whose organisation that acts as energy policy adviser Standards Board Statement 133. ISO). ISO responsibilities vary by jurisdiction, home currency is, for example, sterling would to 28 member countries. Founded during the but can include co-ordinating scheduling be exposed to both US dollar currency risk and oil crisis of 1973-74, the IEA’s initial role was ICE for transmission transactions; overseeing the crude oil price risk. A possible integrated hedge to co-ordinate measures in times of oil supply H see IntercontinentalExchange instantaneous balancing of generation and would be a quanto product, which would hedge emergencies. Its mandate has broadened to load; managing and redispatching generation the price of crude oil in pounds sterling. incorporate the ‘four Es’ of balanced energy IEA in system emergencies; managing operating H see also exchange option policy-making: energy security, economic H see International Energy Agency reserves; ensuring new transmission facilities development, environmental protection and are built when and where needed; and Interconnector engagement of producers and consumers. Imbalance energy co-ordinating transmission payments. In some A gas pipeline running from Bacton in Norfolk, Current work focuses on climate change The difference between hourly scheduled cases, ISOs are also responsible for managing England, to Zeebrugge in Belgium. It opened in policies, market reform, energy technology electricity deliveries and hourly metered power exchange activities. October 1998 and allows Britain to export gas collaboration and energy research. deliveries. Typically, energy imbalances are to, or import gas from, continental Europe for eliminated during a future period by returning Independent power producer the first time. International Petroleum Exchange (IPE) energy in kind under conditions similar to A (US) entity that owns or operates facilities for Formerly an independent London those when the initial energy was delivered. the generation of electricity, primarily for public IntercontinentalExchange (ICE) energy exchange, in June 2001 the IPE When energy imbalances exceed a prespecified use, and is not an electric utility. Atlanta, Georgia-based IntercontinentalExchange became a wholly owned subsidiary of threshold (for example, +/–1.5% of the operates leading regulated exchanges, trading IntercontinentalExchange. Since then, its name scheduled transaction), imbalances are resolved Index platforms and clearing houses serving global has been changed to IntercontinentalExchange through monetary payments. A numerical value assigned to a group of markets for agricultural, credit, currency, Futures Europe and trading has been shifted commodities, stocks or prices in order to give emissions, energy and equity index markets. onto an electronic trading platform. This an indication of market trends. ICE has expanded its business into several markets exchange has futures and options contracts for The volatility level that, assuming a certain since it was established in May 2000. In July 2010, energy products including Brent blend crude pricing model, equates the calculated value of injection it acquired the Climate Exchange, a leader in the oil, gasoil natural gas, electricity (baseload the option to its current market price. The process of placing natural gas in development of traded emissions markets. and peakload), coal contracts and carbon H see also volatility skew, , volatility underground storage or the producing reservoir emission allowances. term structure in order to maintain pressure. Interdelivery spread Futures or options trading techniques that Interruptible service Inadvertent energy Inside FERC entail buying one month of a contract and Gas or electricity sales that are subject to NOTThe imbalance ofFOR routine energy flows REPRODUCTION back and A weekly newsletter produced by publishing NOTselling another monthFOR of the same contract.REPRODUCTION For interruption for a specified number of days or forth between a power generator and the centres company Platt’s that covers the activities of the example, buying a June electricity contract and hours during times of peak demand or in the of demand. These imbalances are typically settled Federal Energy Regulatory Commission. simultaneously selling a September electricity event of system emergencies. In exchange for through exchanges of physical product. contract. A market participant can profit (or interruptibility, buyers pay lower prices. lose out) as the price difference between the H see also firm service, firm (uninterrupted), contracts widens or narrows. non-firm service

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Interstate Investment Services Directive (2nd) (US) The sale of natural gas, oil, or electricity A European Union proposal in 2002 to upgrade across state boundaries. All such interstate sales the 1993 Investment Services Directive, that are subject to the Federal Energy Regulatory covered investment services and regulated J K Commission’s jurisdiction. markets. The proposal required energy firms wishing to trade financial products and certain Japanese Crude Cocktail (JCC) Kansas City Board of Trade Interstate commerce cash-settled commodity derivatives instruments A commonly used reference price index for A Kansas City, Missouri-based exchange that (US) An interchange of goods or commodities, to be authorised as investment firms. The long-term liquefied natural gas contracts in lists wheat. Hard red winter wheat futures are that involves transportation between states. Investment Services Directive was replaced by Japan, as well as Taiwan and South Korea, and is the major mainstay of the exchange. It represents the Markets in Financial Instruments Directive published monthly by the Japanese government the majority of US wheat production and is In-the-money in 2007. representing the average crude oil import price acknowledged as the international benchmark An option that can be exercised and immediately into Japan. for bread wheat prices. In 2010, the exchange closed out against the underlying market for a Inverse traded more than 5.5 million wheat futures cash credit. The option is in-the-money if the H see backwardation Jensen Index contracts, equivalent to more than 27.75 billion underlying futures price is above a call option’s H see alpha bushels of wheat. strike price or below a put option’s strike price. Investor-owned utility H see also at-the-money, out-of-the-money An electricity utility owned by a group of Jet Kappa investors, the shares of which are traded on Jet fuel available in various grades as Jet-A, Jet A value representing the expected change in the Intrastate public stock markets. A-1 and Jet B. price of an option. Also known as lambda. (US) Sales of natural gas, oil or electricity that H see kerosene occur within a single state and do not cross state IPE Kerosene boundaries. They are not subject to the Federal H see International Petroleum Exchange Joint implementation Medium-light distillate used as fuel for jet Energy Regulatory Commission’s jurisdiction. A mechanism defined in Article 6 of the Kyoto engines, with a boiling range of 150°–260° IPP Protocol, allows a country with an emission Celsius. Also called jet kerosene. Intrinsic value H see independent power producer reduction or limitation commitment under The difference between the underlying price the Kyoto Protocol (Annex B Party) to earn Kholodnyi model and the strike price of an option. Isda Master Agreement emission reduction units from an emission A valuation model developed by the The International Swaps and Derivatives reduction or emission removal project in mathematician Valery Kholodnyi for use in Introducing broker Association over-the-counter derivatives Master another Annex B Party, each equivalent to one valuing and hedging electric power price risks Any person who is engaged in soliciting or in Agreement was drawn up by the New York- tonne of CO2, which can be counted towards in environments of extreme price spikes. accepting orders for: the purchase or sale of based trade association in 1987 and revised in meeting its Kyoto target. Joint implementation any commodity for future delivery, security 1992 and 2002. The agreement is commonly is intended to offer parties a flexible and cost- Kilowatt (KW) futures product or swap; any commodity used for contracts in various energy derivatives efficient means of fulfilling a part of their Kyoto 1,000 watts. option authorised under Section 4c of the US markets, especially the US gas market. commitments, while the host party benefits Commodity Exchange Act; and any leveraged from foreign investment and technology transfer. Kilowatt hour (KWh) transaction authorised under Section 19 of ISO Joule Unit of electricity equivalent to the power the US Commodity Exchange Act, who does H see independent system operator A metric unit of energy equal to one watt- of one kilowatt operating for one hour. For not accept any money, securities or property second. example, 10 100-watt light bulbs burning for one (or extend credit in lieu thereof) to margin hour would consume 1KWh of electricity. NOTguarantee or secure FOR any trades or contracts REPRODUCTION NOTJump-diffusion FOR model REPRODUCTION that result or may result there from. Associated A method of pricing contracts that includes Kurtosis persons and futures commission merchants are occasional moves larger than traditional random A parameter describing the peakedness and not introducing brokers. processes would generate. tails of a probability distribution relative to the benchmark lognormal distribution.

★ ★ ENERGY RISK GLOSSARY 2 0 1 1 ENERGY RISK GLOSSARY 2 0 1 1 COMMODITY RISK MANAGEMENT & TRADING COMMODITY RISK MANAGEMENT & TRADING

Kyoto Protocol on Climate Change LDZ Leptokurtosis Lincoln Amendment An agreement made in Kyoto, Japan, in H see local distribution zones The property of a statistical distribution to have A section of the Dodd-Frank Act that effectively December 1997 under which industrialised more occurrences far away from the mean than forbids Federal Deposit Insurance Corporation countries agreed to adopt specific goals Lean gas would be predicted by a normal distribution. (FDIC)-insured institutions and other entities and timelines for nationwide reductions of H see see dry gas Also referred to as ‘fat tails’. that have access to credit greenhouse gas emissions between 2008 and facilities – including , thrifts and US 2012. The two major mechanisms for achieving Lean LNG branches of foreign banks – from acting this established under the protocol are emissions Liquefied natural gas (LNG) that is of a Instrument or document issued by a bank as a swap dealer except in certain limited trading and the Clean Development Mechanism. specification with very low, high heating guaranteeing the payment of a customer’s drafts circumstances, thus requiring such institutions to The EU and its Member States ratified the value (HHV). Lean LNG liquid stream is up to a stated amount for a specified period. It ‘push out’ most swap-dealing activities into an Kyoto Protocol in May 2002. The EU has a predominately methane with some minor substitutes the bank’s credit for the buyer’s and affiliate that is not FDIC-insured and does not target goal of 8% reduction in greenhouse gases quantities of ethane. Lean LNG may be eliminates the seller’s risk. otherwise access Federal Reserve credit facilities. and Japan’s goal is a 6% reduction. The Protocol required to meet fuel quality specifications and H see also performance letter of credit H see also Dodd-Frank came into effect for all signatory countries on standards required by LNG-powered vehicles February 16, 2005. As of March 2011, the US and other LNG-fuelled equipment. Leaner Leverage Linear least squares had not ratified the Kyoto Protocol. LNG can be produced through the extraction The ability to control large amounts of an The principle or method by which the fit of the heaviest components, namely the LPGs, underlying variable for a small initial investment. of a function to data is such that the sum of propane and butane. Rich LNG, or Hot LNG, Futures and options are leveraged products, the squared residuals is minimised. In linear with high HHV also produced for some because the initial premium paid is usually regression, the function is a line. market segments. much smaller than the nominal amount of the The sum of the squares of the residuals is H See also hot LNG underlying. Leverage is usually measured as the used instead of the absolute values because this L effective gearing. allows the residuals to be treated as a continuous La Niña H see also gearing differentiable quantity. However, because squares The name given to the periodic cooling of the The risk that a counterparty to a transaction of the residuals are used, outlying points can have tropical Pacific Ocean, hence the name: it means will not be liable to meet its obligations under LF a disproportionate effect on the fit, a property ‘little girl’ in Spanish, the opposite of El Niño. law. Such difficulties may arise from a number H see load factor that may or may not be desirable depending on La Niña occurs after some, but not all, El Niños. of causes, one of the most common being the particular problem being considered. During a La Niña year, US winter temperatures that the transaction was not sufficiently well- Libor are warmer than normal in the southeast and documented to be legally enforceable. The London Interbank Offered Rate – the rate Line losses cooler than normal in the northwest. of interest at which banks borrow funds from The difference between the quantity of Legal and regulatory compliance risk other banks, in marketable size, in the London electricity generated and delivered at some point Lambda The risk that a counterparty’s performance interbank market. in the electricity system. Losses vary depending H see gearing obligations will be unenforceable because: on temperature, voltage level and load levels. (i) the underlying transaction documentation Lifting Laytime is inadequate; (ii) the counterparty lacks The loading of crude oil or oil products on to Line packing/filling The amount of time specified as allowable in the requisite authority or is subject to legal a vessel. Raising the pressure within a gas pipeline a shipping charter contract for loading and transaction restrictions; (iii) the underlying system in order to increase the system’s storage unloading of cargo. Demurrage is incurred if the transaction is impermissible under applicable Light capability – important for system operation. laytime is exceeded. law or regulations; or (iv) applicable bankruptcy Typically crude oil with an American Petroleum NOT FOR REPRODUCTIONor insolvency law or regulations limit or alter NOTInstitute gravity FORof more than 28 degrees. REPRODUCTIONLiquidated damage clause LCH contractual remedies. It also is intended to cover This clause allows a counterparty that is owed H see London Clearing House the risk of mandated regulatory compliance. Light ends power to charge the defaulting counterparty Volatile hydrocarbon products, such as propane, for the price of having to buy elsewhere. The LDC butane, gasoline and naphtha. higher the price, the higher the charge when a H see local distribution company company defaults on its supply obligations.

★ ★ ENERGY RISK GLOSSARY 2 0 1 1 ENERGY RISK GLOSSARY 2 0 1 1 COMMODITY RISK MANAGEMENT & TRADING COMMODITY RISK MANAGEMENT & TRADING

Liquidity LNG Load shedding London Clearing House (LCH) A market is liquid when it has a high level of H see liquefied natural gas The process of removing certain sections of A member-owned clearing house that merged trading activity. customer demand from the supply system in with Clearnet.SA in 2003 to form the LCH. LNG chain response to a shortfall. Clearnet Group. In October 2008, LCH. The components in the liquefied natural gas Clearnet signed a new clearing arrangement The risk that a firm unwinding a portfolio of process for transporting from producing areas to Local distribution company with Liffe, the international derivatives market illiquid instruments may have to sell them at consuming regions, typically comprising stages A company that operates or controls the retail of NYSE Euronext. less than their fair value. An illiquid market for liquefaction, transportation and regasification. distribution system for the delivery of natural may be defined as one characterised by wide gas or electricity. Long bid/ask spreads, lack of transparency and large LNGRV The buyer of a financial contract. movements in price after any sizeable deal. Liquefied natural gas regasification vessel. Local distribution zones Twelve zones in the UK managed by four Long position Liquefied natural gas (LNG) Load distribution network operators. The National A position that appreciates in value if the LNG is compressed natural gas (mainly methane The amount of power carried by a utility Grid has divided the UK into local distribution value of the underlying instrument or market and ethane), which (unlike liquefied petroleum system or sub-system, or the amount of power zones for the purpose of calculating shippers’ price increases. gas) is reduced to a liquid form by cooling it to consumed by an electrical device, at a specified charges for transporting gas within the national -259° Farenheit. The volume of LNG is 1/600th time. Load is also referred to as demand. transmission system. Gas is delivered to the local of its volume as gas vapour. It is odourless, distribution zones via the National Transmission A lookback call (put) option grants the right colourless, non-toxic and non-corrosive. LNG Load factor System (NTS), which then supply the end-user. to buy (sell) the underlying energy commodity is much easier and more cost-effective to store The ratio between average and peak usage for This is achieved via a less pressurised system at the lowest (highest) price reached during and to transport, especially where pipelines do electricity or gas customers. The higher the than the NTS. the life of the option. Effectively, the best price not exist. load factor, the smaller the difference between from the point of view of the holder becomes average and peak demand. Locals the strike price. Liquefied petroleum gas (LPG) Members of a futures exchange who trade A light hydrocarbon composed mainly of Load following exclusively on their own account. Loop propane and butane, occurring naturally Continuous balancing of generation and load Louisiana Offshore Oil Port. A US deepwater in crude or from refining processes such accomplished by committing online generation Location spread port that can accommodate vessels as big as as crude distillation, catalytic reforming or whose output is raised or lowered as necessary The differential between the prices quoted for ultra-large crude carriers with a loaded weight hydrocracking. Gaseous at atmospheric pressure to follow moment-by-moment changes in load. the same commodity at two locations. of more than 200,000 deadweight tons. and temperature, LPGs are liquefied by reducing temperature or increasing pressure for ease of Load shape Locational marginal pricing (LMP) Loop flows transportation and storage. A combination of electricity contracts covering A method of pricing the cost of congestion Unintended flows on electricity transmission a period of weeks or months, which reflects into electricity prices. The Federal Energy systems that occur as a by-product of the Liquefaction plant the profile of the daily power requirements of a Regulatory Commission is introducing LMP dispatch of electricity down an intended path. A facility that converts natural gas from its customer or distribution of energy requirements under its standard market design proposals. natural gaseous state to a liquid state. The gas is over time. LMP aims to encourage the efficient use of the Lot first cleaned of all traces of CO2, water, mercury H see also load shape 44 transmission system by assigning costs to users The unit size for transactions on a given and sulphur. It is then cooled to -160° Celsius based on the way energy is actually delivered. futures exchange. in cold boxes until it becomes liquid. In this Load shape 44 NOTform, it is stored FORin tanks. REPRODUCTIONA benchmark load shape traded on the UK NOTLognormal distribution FOR REPRODUCTIONLouisiana light sweet (LLS) electricity forward market. It comprises 5 A probability distribution such that the natural A low viscosity (light), low sulphur (sweet) LLS megawatts (MW) of baseload power and 5MW logarithm of the variable is normally distributed. crude oil produced in the Gulf of Mexico. H See Louisiana light sweet of additional power between 07:00 and 19:00 UK time on week days. LPG H see also load shape H see liquefied petroleum gas

★ ★ ENERGY RISK GLOSSARY 2 0 1 1 ENERGY RISK GLOSSARY 2 0 1 1 COMMODITY RISK MANAGEMENT & TRADING COMMODITY RISK MANAGEMENT & TRADING

Margin Market risk Material adverse change Cash deposits required for a contract that serve The risk that value will be lost due to a change Any negative event affecting a company that as a good-faith deposit guaranteeing that both in some market variable, such as commodity or is deemed to be material by a creditor. Such M parties to the agreement will perform the equity prices, interest rates or foreign exchange events can either be defined or undefined in the transaction at some point in the future. rates. The market risk of a derivatives position contract between the company and its creditors. m may arise from a change in the value of the Symbol in the energy market denoting one Margin call underlying or from other sources such as mcf thousand – for example, mbbl = 1,000 barrels. A call from a clearing house to a clearing implied volatility or time decay (theta). Thousand cubic feet. member or from a broker or firm to a customer, MA to bring margin deposits up to a required Market value MDQ Moving average. minimum level. H see replacement cost Maximum daily quantity. The upper limit for the amount of gas a buyer may take in a single McCloskey (Coal) Margin risk Mark-to-market 24-hour period. A source of news, analysis and data on the The risk that a company will fail to make a To mark-to-market is to calculate the value international coal industry. margin call. of a financial instrument (or portfolio of such Mean instruments) at current market rates or prices of Often considered as the simple arithmetic mm Marginal cost the underlying. Marking-to-market on a daily average of the sum of the observed values Symbol in the energy market denoting one The change in cost resulting from production of (or more frequent) basis is often recommended divided by the number of observations. It is million – for example, mmBtu = million British a single additional unit of production. in risk management guidelines. customary to represent the mean by µ. thermal units. H see also accrual accounting, hedge accounting Marker crudes Mean reversion Major swap participant Crudes against which other crudes are priced. Mark-to-model A tendency for a stochastic process to revert An entity that: (i) maintains a substantial position Widely used marker crudes include West Texas A means of calculating the value of a financial over time to an equilibrium level, such as the in swaps (excluding positions held for hedging Intermediate (for US destinations), Brent instrument by using standard models to value average (the mean) of historical prices, or some risk); or (ii) holds sufficient outstanding swaps blend (for European destinations) and Dubai both the price of the underlying commodities other variable. Interest rates, stock returns, to create substantial counterparty exposure that (for far eastern destinations). and also the risk metrics of the financial price-earning ratios, and implied volatilities could seriously affect the US banking system or H see also benchmark crude instruments themselves. Mark-to-model is tend to exhibit mean reversion. The concept financial markets. generally used when the underlying price is not of mean reversion has been much discussed Market-maker easily observed in the market and/or where the in energy markets with reference to how to Make-up gas An energy trader or energy trading firm that financial instrument is a complex combination best model forward prices in markets such as In a gas buyer’s contract there are often terms is prepared to buy and sell in the derivatives of standard products. deregulated power. that allow the buyer to take make-up gas in market to provide a two-sided (bid/ask) market contract periods after it has been paid for but and greater liquidity. Master agreement Megajoule (MJ) not taken. There may be a limit to the amount The model master power purchase and sale One million joules (sometimes MMJ). of make-up the buyer can recover in any Market-on-close agreement is an attempt to standardise the given period. An order to buy or sell a specified amount core terms and conditions needed to establish Megawatt (MW) H see also take or pay of futures contracts at the price when the trading relationships in the US power markets One million watts (sometimes MMW). market closes. by providing standard documentation for all MAQ trading agreements. The master agreement was Megawatt hour (MWh) NOT(Gas) Maximum FORannual quantity. REPRODUCTIONMarket power NOTdeveloped by Washington, FOR DC-based REPRODUCTIONEdison One million watt hours. The multiple of the H see annual cap The ability of a trader to significantly control Electric Institute, an association of US electricity power in megawatts times the time in hours or affect the market price by withholding companies, and implemented in spring 2000. and is the measurement unit commonly used in production from the market, limiting service H see also model master power electric power trading and supply markets. availability or reducing purchases.

★ ★ ENERGY RISK GLOSSARY 2 0 1 1 ENERGY RISK GLOSSARY 2 0 1 1 COMMODITY RISK MANAGEMENT & TRADING COMMODITY RISK MANAGEMENT & TRADING

Metering facility Minneapolis Grain Exchange Monte Carlo simulation Multi-factor model A facility that measures and registers the amount Established in 1881 as the Minneapolis A method of pricing derivatives by simulating the Any model in which there are two or more and direction of natural gas or electricity Chamber of Commerce. Became the evolution of the underlying variable (or variables) uncertain parameters in the option price (one- flowing through the facility. Minneapolis Grain Exchange (MGE) in 1947. many times over. The average outcome of the factor models incorporate only one cause of in addition to trading wheat and shrimp simulation is an approximation of the derivative’s uncertainty: the future price). Meters futures contracts, on September 14, 1998, MGE value. Monte Carlo is useful in the valuation of Such models can be more realistic than one- Equipment used to measure the movement of launched its twin-cities generation region complex derivatives for which exact analytical factor models, particularly in modelling complex gas or electricity flowing across various points in electricity futures and options contracts. It is the solutions have not been found, but it can be variables, such as interest rates. Other problems, the system. Where meters giving daily volume first futures exchange to list electricity futures very computationally intensive. Monte Carlo such as modelling spread options, automatically consumption are used, the sites are known as with an upper US Midwest delivery point. It is simulation can also be applied to a portfolio of require a multi-factor model. daily metered (DM) sites. At smaller supply also the first to list off-peak electricity futures instruments, rather than a single instrument, to points, readings are taken at longer intervals and and options contracts. estimate the value-at-risk of that portfolio. Multi-factor option are called non-DM sites. Any option, such as a spread option, whose mmBtu Most-favoured nation clause payout is linked to the performance of more Methyl tertiary butyl ether (MTBE) Millions of British thermal units. Originally a provision of international treaties than one asset. Its value is usually strongly A substance that can be added to gasoline to providing that one or both of the parties to dependent on the correlation between increase its oxygen content and thereby make mmscfpd the treaty would be granted the same terms underlying assets. it burn more cleanly. MTBE has been used in Millions of cubic feet of gas per day. as that of the most favourable terms provided some areas of the US since 1990, from which any other country, currently or in the future, Multilateral netting time the Clean Air Act required the use of Model master power for some stipulated aspect such as tariffs. Now An arrangement between a number of parties, gasoline with a 2% oxygen content in areas of Purchase and sale agreement. also a feature used in commercial contracts in which each pays into a clearing house for high pollution. More recently, MTBE has been H see also master agreement guaranteeing the recipient the best price or net obligations due to other parties. Multilateral linked to water pollution incidents and is being terms offered to any other counterparty. netting is a way of reducing credit risk. phased out in favour of ethanol in many areas. Moments [of a statistical distribution] H see also bilateral netting, netting The shape of any distribution can be described Moving average Metric ton (tonne) by its various ‘moments’. The first four are: The average of commodity prices constructed Mutual offset system A metric ton is 2,204.62 pounds. ● The mean, which indicates the central for a period as short as a few days or as long as A margining system for derivatives exchanges, in tendency of a distribution. several years, which shows trends for the latest which positions on different exchanges can be Mibel ● The second moment is the variance, which interval. For example, a 30-day moving average offset with each other. If a participant has a long Mercado Iberico de Electricidad, the joint indicates the width or deviation. includes yesterday’s figures; tomorrow, the same position on one exchange but a short position Spanish-Portuguese electricity market that ● The third moment is the skewness, which average will include today’s figures and will no on another in a fungible (compatible) contract, came into effect in 2005 and allows participants indicates any asymmetric ‘leaning’ to either left longer show those for the earliest date included in he can reduce (or eliminate) margin payments on to buy and sell power on either side of the or right. yesterday’s average. Every day it records figures for one exchange because overall exposure has been Spain/Portugal border to create a pan-Iberian ● The fourth moment is the Kurtosis, which the latest day and drops those for the earliest day. reduced by netting over the two exchanges. market with more than 28 million business and indicates the degree of central ‘peakedness’ or, domestic customers. equivalently, the ‘fatness’ of the outer tails. Moving strike option MW H see also mean Any option whose strike is reset over time. Megawatt (1,000 kilowatts). Middle distillates Oil products in the boiling range of between MTBE NOT160° and 360° Celsius –FOR i.e., between REPRODUCTIONgasoline NOTH see methyl tertiary FOR butyl ether REPRODUCTION and heavy fuel oil. These include gasoil, diesel and jet fuel (kerosene). MTPA Metric tonnes per annum, which is a typical measurement unit in liquefied natural gas markets for production and facility capacity.

★ ★ ENERGY RISK GLOSSARY 2 0 1 1 ENERGY RISK GLOSSARY 2 0 1 1 COMMODITY RISK MANAGEMENT & TRADING COMMODITY RISK MANAGEMENT & TRADING

National balancing point (NBP) National Transmission System (NTS) NetConnect Germany The national balancing point, commonly referred The UK high-pressure pipeline system, owned NetConnect Germany is a joint company to as the NBP, is a virtual trading location for by National Grid, used to transport gas between established 2008 by bayernets GmbH and E.ON N the sale and purchase of UK natural gas. It is the terminals, storage facilities, large consumers and Gastransport for the merged H-gas market area Naked option most liquid gas trading point in Europe. Gas at regional sites. in Germany. The company’s business activities, An option bought or sold without an offsetting the NBP trades in pence per therm. which include balancing group management, position in the underlying. Natural gas operation of the virtual trading point and the H see also covered option National Electricity Code Administrator Gas consisting mainly of methane and ethane online provision of information including billing Made up of the five participating jurisdictions of that occurs naturally in the earth’s crust. It and control energy data, are geared towards Naked swap the Australian National Electricity Market (NEM). is often found in association with crude oil, serving network operators and shippers alike. A swap position without a corresponding asset The aim of the organisation is to promote the when it is called associated gas. Futures and or liability. effectiveness, efficiency and equity of the NEM to options contracts are traded on Nymex and the Net position push the market towards more competition and International Petroleum Exchange. The difference between the entity’s open long Naphtha market-orientated outcomes in order to deliver a contracts and open short positions in any A refined product, between jet and gasoline viable market that benefits customers. Natural gas liquids (NGLs) one commodity. in specific gravity, which is used as a feedstock H see also National Electricity Market Liquids produced along with natural gas. They for the petrochemicals industry – such as for consist mainly of propane, butane, natural Net present value ethylene manufacture or aromatics production – National Electricity Law and Rules gasoline and condensate. A technique for assessing the worth of future and as a refinery feedstock for reforming. The rules for the running of the Australian payments by looking at the present value of Comprises material in the 30°–210° Celsius wholesale national electricity market. It sets out natural hedge those future cash flows discounted at today’s cost distillation range or part of this range. the objectives of the market and the rights and A natural hedge is the reduction in risk that of capital. responsibilities of market participants. can arise from an institution’s normal operating NASDAQ OMX Commodities procedures. A company with significant sales Neta Power exchange that provides marketplaces National Electricity Market (NEM) in one country holds a natural hedge on its H see New Electricity Trading Arrangements for trading in physical and financial contracts The Australian market for the wholesale supply currency risk if it also generates expenses in in northern European countries (primarily and purchase of electricity in the Australian that currency. For example, an oil producer Netback Finland, Sweden, Denmark, Germany, Iceland, Capital Territory, New South Wales, Queensland, with refining operations in the US is (partially) A provision in a physical power contract that the Netherlands, Norway and the UK). It listed South Australia, Tasmania and Victoria, together naturally hedged against the cost of dollar- allows the bearer to net a debt position with the world’s first exchange-traded electricity with the transmission and distribution networks denominated crude oil. While a company can one counterparty by offsetting it with a credit futures contract in October 1995. It now in those states and territories. alter its operational behaviour to take advantage position with another counterparty. operates the world’s largest power derivatives of a natural hedge, such hedges are less flexible exchange and also provides a carbon market for National Futures Association than financial hedges. Netback price trading contracts on emission allowances and An industry-wide, self-regulated organisation A pricing assessment or pricing formula based carbon credits. In 2002, the physical market of for the US futures industry responsible for NBP on the effective price to the producer or seller NASDAQ OMX Commodities was organised reviewing and accepting registrations. H see national balancing point at a specific location or defined point. For into a separate company, Nord Pool Spot AS. example, liquefied natural gas netback prices may H see also Nord Pod Spot AS National Grid Negotiated rate be determined by the market natural gas price An international energy delivery business, whose A rate mutually agreed upon by the pipeline at market destinations less the cost of pipeline National allocation plan (NAP) principal activities are in the regulated electricity and its customer that is different from the transportation, regasification, waterborne shipping NOTA plan to establish FOR the emissions target REPRODUCTIONfor the and gas industries. It owns and operates the high- NOTpipeline’s standard FOR tariff rates. REPRODUCTIONand liquefaction. Crude oil may be priced on the covered sectors and decide how it will be divided voltage electricity transmission network in the market value of its refined products, or natural among the various installations covered by the US, England and Wales, and the UK’s natural gas NERC gas priced based on the natural gas market price system. The Emissions Trading Directive (Article transportation system. H see North American Electric Reliability Corporation less the cost for delivering from the defined 9) stated each Member State must periodically point to the market location. develop such a national allocation plan.

★ ★ ENERGY RISK GLOSSARY 2 0 1 1 ENERGY RISK GLOSSARY 2 0 1 1 COMMODITY RISK MANAGEMENT & TRADING COMMODITY RISK MANAGEMENT & TRADING

Netting New York Mercantile Exchange (Nymex) Non-attainment area North American Energy Standards Board An agreement that offsets the value of contracts US futures exchange, consisting of two divisions: A US geographic area in which air quality is A US industry forum that aims to develop by creating a single net exposure between the Nymex division and the Comex division. worse than that allowed by the US federal air and promote a standard that will lead to counterparties. Along with metals futures and options, the pollution standards. a seamless market for wholesale and retail H see also bilateral netting, multilateral netting exchange offers trading for energy futures natural gas and electricity, as recognised by its and options in crude oil, heating oil, gasoline, Non-firm service customers, business community, participants and Network code natural gas and electricity, as well as propane Electricity transmission service offered to regulatory entities. (UK) The rules governing relations between futures and options on the crude oil/gasoline customers that anticipates possible interruption the National Grid, as operator of the national and crude oil/heating oil crack spreads. In of deliveries. Northeast Power Co-ordinating transmission system, and shippers who use August 2008, Nymex Holdings, the parent H see firm service, interruptible service Council (NPCC) the system. company of Nymex was acquired by CME A North American Electric Reliability Council Group. The exchange also operates the Nymex Non-jurisdictional gas operations within the Eastern Interconnection. Newcastle coal ClearPort® Services for clearing trades, as well (US) Gas sales and transportation outside Federal (Australia) Typically, Newcastle thermal coal as the Nymex ACCESS® system for after-hours Energy Regulatory Commission regulations. prices as traded for the part of Newcastle in trading when the open-outcry trading floor is Notice of proposed rulemaking (NOPR) New South Wales, which is the world’s largest not open. NOPR A Federal Energy Regulatory Commission coal export harbour. H see Notice of Proposed Rulemaking document outlining proposed rules and NGTA soliciting comments from affected parties. New electricity trading arrangements (Neta) H see New Gas Trading Arrangements Nord Pool Spot AS Neta is a system of bilateral trading between In 2002, Nord Pool’s physical market was Notional generators, suppliers and consumers on the UK Nitrogen oxides (NOx) organised into a separate company, Nord The underlying principal value of either market, the aim of which is to reduce wholesale A gas produced by burning fossil fuels in power Pool Spot AS. It operates the largest market an exchange-traded or over-the-counter electricity prices. plants or automobile engines. Nitrogen oxides for electrical energy in the world, offering transaction, referred to as the notional value. H see also Betta are pollutants that contribute to the formation both day-ahead and intraday markets to its of smog. A nitrogen oxide allowance trading participants, which include companies from at Notional path New Gas Trading Arrangements (NGTA) market exists across 11 US states under the US least 20 countries. (Gas) Usually the shortest route along which gas The New Gas Trading Arrangements were Clean Air Act. would travel from entry point to exit point. introduced in the UK in October 1999 in H see also sulphur oxides Normal distribution an attempt to improve the efficiency of the A continuous probability distribution whose Novation balancing system. The arrangements consist of Nomination probability density function has a ‘bell’ shape. The substitution of a new contract for an the on-the-day , auctions The notification to put into effect a contract A normal distribution is symmetric, and has old one or the substitution of one party in a of entry capacity and improved incentives for or part of a contract. For example, a gas flow zero skewness. A normal distribution is fully contract with another party. shippers to balance their own positions. nomination from a shipper to advise the described with two parameters: its mean and

pipeline owner of the amount of gas it wishes to standard deviation. NOx transport or hold in storage on a given day. H see nitrogen oxide North American Electric Reliability Nomination deadlines Corporation (NERC) NTS (US) The deadline for nominations for gas A group formed in 1968 by US utilities, after H see National Transmission System supply, transportation and storage volumes blackouts struck the east coast, to promote the NOT FOR REPRODUCTIONgiven to the pipeline owner for a full month NOTreliability and adequacyFOR of bulk power REPRODUCTION supply in Nymex in the last week of the previous month. This the electricity utility systems of North America. Hsee New York Mercantile Exchange happens around the time of the expiry of the futures contract on Nymex; the actual day varies between pipelines.

★ ★ ENERGY RISK GLOSSARY 2 0 1 1 ENERGY RISK GLOSSARY 2 0 1 1 COMMODITY RISK MANAGEMENT & TRADING COMMODITY RISK MANAGEMENT & TRADING

Off specification On-board regasification On-peak Oil product or gas that does not meet Technologies and capabilities on liquefied natural Refers to hours of the business day when specification. Refers either to contract gas (LNG) vessels for vaporisation of LNG after demand is at its peak. In the US, physical O specification or those benchmark specifications transport to its destination, in order to directly market, on-peak definitions vary by North generally used in the physical market. deliver natural gas to downstream markets. American Electric Reliability Councils. Oasis (US) Open-access same-time information Offsetting On-the-day commodity market (OCM) OPEC system. Electronic information system that Matching two financial transactions on a Part of the new gas trading arrangements Vienna-based Organisation of Petroleum the Federal Energy Regulatory Commission regulated exchange with the same delivery, introduced in the UK in October 1999, the Exporting Countries. OPEC members are requires all transmission operators to create or time and volume against one another to reduce OCM is a screen-based, within-day gas market Algeria, Angola, Ecuador, Iran, Iraq, Kuwait, participate in to provide transmission customers financial obligations. that allows shippers to fine-tune their daily Libya, Nigeria, Qatar, Saudi Arabia, United Arab with non-discriminatory information about gas positions. Emirates and Venezuela. available capacity, prices and other information. Offtake Although OPEC is a dominant force in (UK) Gas removed from the National One cancels the other international oil markets, growth in world OCM Transmission System at reduced pressure. Where a broker is given two alternative orders. demand for oil has at times pushed production H see on-the-day commodity market As soon as one is executed, the other order to near-capacity limits, seemingly reducing Oil products is cancelled. OPEC’s ability to contain oil prices below Oco H see refined products the cartel’s announced target range, which is H see one cancels the other One day in 10 years intended to sustain world economic growth and Oil tanker freight derivatives Reliability standard often applied to electricity limit development of substitute energy sources. Octane Oil tanker freight derivatives are over-the- generation systems. Under this standard, a This was evident with the surge in crude oil An octane number or octane rating is a value counter trades bought and sold in terms of combination of forced and planned outages prices in 2008, before prices collapsed due to used to indicate the resistance of a motor fuel worldscale prices and settled against 11 key would leave the system without enough the global economic downturn. to knock (ping). Octane numbers are based tanker routes listed on the London-based Baltic generation to meet load on a probabilistic basis on a scale on which isooctane is 100 (minimal Exchange. The worldscale system (worldwide on only one day in every 10 years. Open-access transmission knock) and heptane is 0 (bad knock). For tanker nominal freight scale) is a system of The provision of electricity transmission to third example, a gasoline with an octane number of pricing tanker freight as a percentage of One-factor model parties on a non-discriminatory basis. 92 has the same knock as a mixture of 92% expected freight rates as published by the non- A model or description of a system where isooctane and 8% heptane. profit WorldScale Association in a table listing the model incorporates only one variable, or Open-access transportation the price in dollars per tonne of oil for standard uncertainty – the future price. The transportation of gas or electricity for third Odds (betting) routes, and there is a flat rate for each route. parties on a non-discriminatory basis. As typically used in wagering outcomes, the Rates listed – flat rates – are termed WS100, One in twenty (1 in 20) odds of success/winning are expressed in which is the amount needed for a standard Peak-day demand – the highest gas demand the form ‘r:s’ (‘r to s’) and correspond to the vessel to make a profit. Similarly, WS175 means expected on any given day over a 20-year The volume of contracts, long or short, open on probability of succeeding/winning [P=s/(r+s)]. 175% of the published rate. period. The UK gas network is designed to cope an exchange-traded contract. Therefore, given a probability P, the odds of with this calculated level of demand. succeeding/winning are (1/P)-1: 1. OMEL Open outcry Compañía Operadora del Mercado Español One in fifty (1 in 50) Trading by means of shouting bids and offers Odorant de Electricidad has been responsible for the The highest gas demand expected in a single across a trading floor. This traditional method NOT(Gas) Mercaptan FORadded to natural gas REPRODUCTIONto give it organisation and regulation of the Spanish NOTyear out of 50 years.FOR The UK gas pipeline REPRODUCTION of trading is increasingly being replaced by smell so that gas escapes (leaks) can be detected. wholesale electricity pool since its launch system is designed to cope with this calculated electronic trading. in 1998. level of demand. Off-peak Times of relatively low energy demand, typically One-touch option nights and weekends. H see digital option

★ ★ ENERGY RISK GLOSSARY 2 0 1 1 ENERGY RISK GLOSSARY 2 0 1 1 COMMODITY RISK MANAGEMENT & TRADING COMMODITY RISK MANAGEMENT & TRADING

Operational risk Out-of-the-money Path-dependent option The risk that a firm’s internal practices, policies An option with no intrinsic value. For calls, A path-dependent option has a payout and systems are not adequate to prevent a an option with an exercise price above the dependent on the price history of the loss being incurred, either because of market market price of the underlying future. For puts, P underlying overall or part of the life of the conditions or operational difficulties. Such an option with an exercise price below the option. The most common form of option in deficiencies may arise from failure to measure or futures price. Pacific Basin over-the-counter energy risk management (the report risk correctly, or from a lack of controls H see also in-the-money The geographical region of the land mass, Asian option) is a path-dependent option, as are over trading staff. Although is including islands, bordering the Pacific Ocean. lookback and barrier options. harder to define precisely than market or credit Outliers As applied typically in liquefied natural gas risk, it is considered by many to have been a Probabilistically remote events that are often (LNG) trading, the Pacific Basin LNG market Payoff diagram contributor to some of the highly publicised viewed as statistically independent as well. consists of present and future producers: A graph of a transaction’s payoff as a function of losses of recent years. Various techniques can test if actual data differs Abu Dhabi, Australia, Brunei, Indonesia, Iran, the value of the underlying at expiration. in a statistically significant manner from the Malaysia, Oman, Papua New Guinea, Peru, Option benchmark or normal distribution. Qatar, Russia, the US and Yemen; and current Pay-later option A contract that gives the purchaser the right, but and future LNG consumers: China, India, Any option for which a premium is not paid not the obligation, to buy or sell the underlying Over-the-counter (OTC) Indonesia, Japan, Pakistan, Mexico’s West Coast, at the time the option is purchased. Payment commodity at a certain price (the exercise, or An over-the-counter deal is a customised Singapore, South Korea, Taiwan, Thailand and of the premium may be deferred until expiry, strike, price) on or before an agreed date. derivatives contract usually arranged with the US West Coast. when it may be deducted from any payout. H see also exotic option, vanilla option an intermediary such as a major bank or the Note that a Pacific Basin LNG producer trading wing of an energy major, as opposed to might not be physically located in the Pacific Peak load Option on future a standardised derivatives contract traded on an Basin itself. Periods during the day when energy H see futures option exchange. Swaps are the most common form of H see also Atlantic Basin consumption is highest. The introduction of OTC instrument. additional gas or electricity to cover this demand Option replication Padd is known as peak shaving. H see replication Own-use gas H see API regions The gas taken from a pipeline to drive Peak shaving Option premium compressors or to preheat gas. Palo Verde During times of peak demand, supplies from The amount that an option buyer pays to Site of the high-voltage switchyard in Arizona sources other than normal suppliers are used to the seller. Oxygenate linking the utilities of the southwest US with reduce demand on the system – for example, A gasoline fuel additive containing hydrogen, those of California. storage from a salt cavern. OTC carbon and oxygen. The oxygen content H see over-the-counter promotes more complete combustion of Paper market Peaking generation gasoline, which reduces exhaust emissions of A market for contracts where delivery is settled Electricity-generating equipment normally Outages carbon monoxide. in cash, rather than by delivery of the physical operated to serve loads only during annual A planned outage is the shutdown of a product on which the contract is based. peak loads or during system emergencies. Often generating unit, transmission line, or other combustion turbines. facility for inspection and maintenance, in Parametric accordance with an advance schedule. A term used to classify curves for which the PEG (France) A forced outage is the unplanned loss of path is described by a mathematical function Points d’Échange de Gaz, which are trading NOTservice of a generating FOR unit, transmission REPRODUCTION line or NOTrather than a set FORof co-ordinates. REPRODUCTIONhubs for the wholesale natural gas markets and other facility for purposes other than inspection are virtual points in each balancing zone. and maintenance.

★ ★ ENERGY RISK GLOSSARY 2 0 1 1 ENERGY RISK GLOSSARY 2 0 1 1 COMMODITY RISK MANAGEMENT & TRADING COMMODITY RISK MANAGEMENT & TRADING

Performance letter of credit Pipeline interconnect Portfolio optimisation Power pool Letter of credit used to guarantee performance Where large pipelines meet and gas can be Use of a linear or quadratic model to structure (US) An association of interconnected electric under a contract. switched from one pipeline to another, such as a portfolio to maximise or minimise yield and systems with an agreement to coordinate H see also letter of credit Henry Hub in the US. long-term rate sensitivity, or to increase or operations and planning for improved reliability reduce exposure to certain industries, market and efficiencies. Petrochemicals PJM sectors or macro-economic factors, subject to Chemicals produced from hydrocarbons used, The PJM Interconnection electricity market pre-specified constraints. Powerhouse for example, in the manufacturing of products for Delaware, Illinois, Indiana, Kentucky, A structure at a hydroelectric plant site that such as plastics. Maryland, Michigan, New Jersey, Ohio, Position limits contains the turbine and generator. Pennsylvania, Tennessee, Virginia, West Virginia, H see speculative position limits Phelix and Washington, DC. The Nymex trades PJM Powernext The Phelix or Physical Electricity Index is the futures contracts. Postage stamp rate A Paris-based company operating a European reference price for power in Germany, Austria Rate structure in which each customer in a energy exchange that provides an electronic and large parts of central Europe. It is calculated Platt’s given class is charged the same rate for a market for the trading of energy contracts daily as the average price for base load (Phelix Energy price information provider, specialising commodity as every other customer, regardless in Europe. It was created in 2001 with the Day Base) and peak load (Phelix Day Peak) in news, prices, data, analysis, analytical tools, of the cost of serving different customers in the opening of the European electricity market, electricity traded on the European Energy research and consultancy services. same class. Also refers to rates set for all and encompasses a network of more than 75 Exchange Spot Market. customers in a given territory, regardless of their European members, including energy producers Polish Power Exchange distance from the point where the given service such as RWE, EDF, Gaz de France, Electrabel Phelix base Warsaw-based electricity exchange operating a or commodity is supplied. and Endesa, as well as end-users, banks, brokers, Hourly weighted average index price per day day-ahead spot market for companies trading traders and retailers. for the hours 1–24 on the Polish power market. The Polish Power Power Exchange was launched in July 2000. Another word for electricity. Power pool Phelix peak A system of trading wholesale electricity that Hourly weighted average index price for the Pollution credits Power exchange determines which generating sets or plants hours 9–20 (08:00–20:00) Monitored by the US Environmental Protection An entity set up to provide an efficient, are called to meet demand for power at any Agency, US-based companies have a limit on competitive trading arena, open on a non- particular time and sets the price of power for Physical the various types of pollution they can produce. discriminatory basis to all electricity suppliers, that period. Pools are deemed necessary by their 1) Synonymous with wet. Crude oil or oil If the actual pollution they produce is below which meets the loads of all exchange customers proponents because electricity generally cannot product with a precise loading window attached this level, they have pollution credits they can at efficient prices. be stored easily and demand has to be met to it. For crude, the loading window is normally trade. This process is known as emissions trading. through simultaneous production. three to five days. An example of a US-based emissions market is Power marketer 2) Trading in a physical commodity (versus SO2 allowances trading. (US) Wholesale power entity that has Precipitation swaps over-the-counter or futures contracts). registered with the Federal Energy Regulatory Instruments linked to the degree of rainfall or Pooling point Commission to trade wholesale power with snowfall. The party taking out a precipitation Pipeline imbalance A switching and interconnection facility in a other power marketers and public entities swap would receive payment for precipitation Companies that transport and use storage physical location through which counterparties at market-based prices. Power marketing above a certain level. facilities in a pipeline system are obliged by the connect. companies include investor-owned, utility- pipeline operator to keep their input and offtake affiliated companies; natural gas marketing Pre-FEED contracts NOTvolumes in balance FOR (within tolerance REPRODUCTIONlimits). If Portfolio NOTcompanies; financial FOR intermediaries; REPRODUCTIONReferring to pre-Front End Engineering and there is a positive or negative pipeline imbalance, The collective term for an owner’s holdings of independent power producers; and Design, for pre-project planning. the transporting firms are heavily financially assets, liabilities, transactions and/or trades. entrepreneurs. Typically, power marketers do penalised by the pipeline. not own generating facilities. Premium H see also electricity utility H see option

★ ★ ENERGY RISK GLOSSARY 2 0 1 1 ENERGY RISK GLOSSARY 2 0 1 1 COMMODITY RISK MANAGEMENT & TRADING COMMODITY RISK MANAGEMENT & TRADING

Premium-reduction device Prompt month Purchased capacity A strategy that aims to reduce the cost of an The first month forward for which a futures The amount of electricity and capacity available option or other derivative. There are three main contract is being traded. Also known as the for purchase from outside a utility system. ways to achieve this: selling a second derivative front month. Q to reduce the overall cost of a strategy; limiting Purpa the payout profile of the derivative; or accepting Proprietary trading H see Public Utility Regulatory Policies Act Qualifying facility (QF) payments below market rates. Entering into a standardised contract to take a (US) A generator or small power producer view, capture market price changes or put capital Put-call parity that meets certain ownership, operating and Pre-schedule at risk. Prop trading is conducted through trades Put-call parity states that the payout profile of a efficiency criteria established by the Federal To schedule for delivery of physical power on a in a bank or energy firm’s own account rather portfolio containing an asset plus a put option Energy Regulatory Commission (FERC) and day-ahead basis. than with customer capital. is identical to that of a portfolio containing a that has filed with FERC for QF status or call option of the same strike on that same asset has self-certified. QFs are physical generating Price cap Public Utilities Commission (PUC) (with the remainder of the money earning the facilities. Price control over electricity or gas prices. An entity that regulates intrastate electricity risk-free rate of return). This can be used to transactions and retail electricity services. arbitrage a position. Quant Price risk Although the various PUCs work A quantitative analyst who applies mathematical Potential fluctuations in the price of the independently of the Federal Energy Regulatory Put option and statistical techniques. underlying energy commodity. Commission (FERC), they must generally abide An option giving the buyer, or holder, the right, by FERC guidelines, as established by various but not the obligation, to sell a futures contract Quantile Primary market federal statutes. They are also commonly known at a specific price within a specific period A notion from probability. The specific value of A market where new securities are traded. as Public Service Commissions or PSCs. of time in exchange for a one-off premium a variable that divides the distribution into two payment. It obligates the seller, or writer, of the parts, those values greater than the quantile value Print Public Utility Holding Company Act (PUHCA) option to buy the underlying futures contract and those values that are less. For instance, p The last traded price at any given time for a US federal act of 1935 that grants the Securities at the designated price, should the option be percent of the values are less than the pth quantile. given futures contract. and Exchange Commission, a US financial exercised at that price. regulator, the power to prevent electric H see also call option Quanto product Profit-at-risk (PaR) public utility holding companies from having An asset or liability denominated in a currency Designed to help energy companies develop generation assets in two areas of the US that are Put spread other than that in which it is usually traded. Since strategies to protect their earnings. PaR extends not geographically adjoining. An options position comprising the purchase the combined exposure to the asset and to the quantitative market risk management beyond In August 2005, the Energy Policy Act of 2005 of a put option at one level and the sale of a foreign exchange rate will change continuously, speculative trading operations, to cover all repealed PUHCA, effective in February 2006. It put option at some lower level. The premium the structures must be dynamically hedged. physical energy activities. was replaced by a much weaker set of laws called received by selling one option reduces the cost H see also delta hedging and integrated hedge the Public Utility Holding Company Act of 2005. of buying the other, but participation is limited Project financing if the underlying goes down. Quartile Involves a corporate sponsor investing in and Public Utility Regulatory Policies Act (Purpa) H see also bear spread, bull spread, call spread and Of the three quartiles, the first or lower quartile of owning a single-purpose industrial asset – usually US federal act passed in 1978 that requires vertical spread a list is a number (not necessarily a number in the with a limited life – through a legally independent electricity utilities to buy wholesale power from list) such that at least one-quarter of the numbers entity financed with non-recourse debt. certain types of independent power producers in the list are no larger than it, and at least three- that produce electricity with renewable quarters of the numbers in the list are no smaller NOTPrompt barrel FOR REPRODUCTIONresources. Although still important, open access NOT FOR REPRODUCTIONthan it. The second quartile is the median. The Physical crude for immediate delivery. to electric power transportation has reduced the third or upper quartile is a number such that at significance of Purpa. least three-quarters of the entries in the list are no larger than it, and at least one-quarter of the PUHCA numbers in the list are no smaller than it. H see Public Utility Holding Company Act

★ ★ ENERGY RISK GLOSSARY 2 0 1 1 ENERGY RISK GLOSSARY 2 0 1 1 COMMODITY RISK MANAGEMENT & TRADING COMMODITY RISK MANAGEMENT & TRADING

Raroc Real option Refinery H see risk-adjusted returns on capital A non-traded asset or liability whose profit- A plant where crude oil is separated into and-loss sensitivity to a commodity price or various components, such as usable products or R Rate other market variable mimics that of an option feedstocks. Authorised charges per unit of consumption for contract. Extracting oil from an oilfield is a r a specified time period for any of the classes of classic example of a real option. If oil prices Reforming margins The correlation co-efficient, which provides an utility services provided to a customer. remain low, the field can be left dormant at no The uplift obtained – usually expressed in index of the degree to which paired measures additional cost. If oil prices rise sufficiently, the cents per barrel – from reforming naphtha into co-vary in a linear fashion. It is the square root Rate base profits earned on the sale of the oil will more gasoline. of the co-efficient of determination, described The value of property from which a utility is than outweigh the costs of extraction. below. The correlation co-efficient can range in permitted to earn a specified rate of return as Reformulated gasoline (RFG) value between -1 and 1. established by a regulatory authority. Real-time pricing A cleaner form of gasoline, providing significant Up-to-date prices for commodities, moving reductions in emissions of ozone-forming and r2 Rate case with every purchase or sale. toxic air pollutants. The co-efficient of determination, which varies A proceeding before the Federal Energy between 0 and 1. It is loosely interpreted as Regulatory Commission that involves the Rebate Refund ‘the proportion of variance in y, which can be rates to be charged for a service that a public A rebate is paid to the holder of a derivative, When the Federal Energy Regulatory explained by x’. utility provides. such as a barrier option, if the instrument is Commission (FERC) determines a rate It is the percentage of the total sum of squares knocked out or is never activated. increase is excessive or not justified, FERC can of the dependent variable that the independent Rate of return order a refund to be returned to wholesale or variable explains, after one optimises the The ratio of profits compared to capital or assets. Red retail customers. intercept and the slope co-efficient of the Exchange notation for contracts trading beyond independent variable. In other words, r2 is Rate schedule the next 12 months. For example, in November Regasification the percentage by which volatility of a linear The rates, costs and other provisions under 2009, ‘red December’ refers to December 2010. The vaporisation of liquefied natural gas (LNG) combination of the dependent and independent which service is supplied to a designated class after transport to its destination, in order to variables and a constant declines after choosing of customers. Recourse rate directly deliver natural gas to downstream the optimal intercept and slope co-efficient. A cost-of-service based rate for natural gas markets. Regasification has traditionally been Rating trigger pipeline service that is on file in a pipeline’s done by the LNG ships offloading their cargo Any number of contractual clauses that call for tariff and is available to customers who do not as liquid into tanks at on-shore terminals, An option in which the underlying factors some change in the counterparty relationship, negotiate a rate with the pipeline company. which then convert it to natural gas. However, are referred to as colours. Hence, a two-factor given a change in the debt rating. technology now exists for regasification on option, such as a spread option, would be a two- Reference price board specially designed vessels, such as Energy colour rainbow option. Ratings cliff In an energy derivatives contract, the market Bridge LNG ships, to deliver natural gas The point at which a company may be spiralling price reference based on a particular location directly into the pipelines. Similarly, dockside Range binary towards further rating downgrades once a rating or specified grade or blend of the commodity, regasification can be done at specially equipped A range binary pays out if a specified spot rate trigger has been initiated. which is used for settlement of the contract. seaports such as at the GasPort now operational trades within a given range over a specified in the UK. period of time, in exchange for payment of a Reference temperature premium. The lower the volatility of the spot A ratio spread involves buying different amounts A typical index variable in weather derivative Regional transmission organisations (RTOs) NOTrate, the more likely FOR the buyer is to benefit.REPRODUCTIONof similar options with differing strike prices. NOTtransactions. FOR REPRODUCTIONOrganisations to administer the electricity H see corridor option, trigger condition The purchase of an in-the-money option is transmission grid on a regional basis throughout financed by the selling of out-of-the-money Refined products North America (including Canada). Creation of Range forward options. Conversely, the out-of-the-money The products derived from crude oil that has RTOs was encouraged by the Federal Energy H see cylinder options are financed by selling in-the-money been processed in a refinery. Regulatory Commission (FERC) under the options. terms of FERC order 2000.

★ ★ ENERGY RISK GLOSSARY 2 0 1 1 ENERGY RISK GLOSSARY 2 0 1 1 COMMODITY RISK MANAGEMENT & TRADING COMMODITY RISK MANAGEMENT & TRADING

Regression analysis second transaction determines the repo rate, the Reversal Risk measurement An analysis to relate one or more dependent interest rate earned on the security between the To take advantage of mispriced options by Assessment of a firm’s exposure to risk. variables to one or more independent variables. two transactions. In a reverse repo, the buyer creating a synthetic long futures position and sells cash in exchange for a security. hedging it by selling futures contracts against it. Risk premium A trader may buy an undervalued call, at the A payment that factors in the inherent risk of a The risk that an asset manager will be unable to Reserve margin same time selling a fairly valued put and buying trade. match the yield from an interest rate instrument The amount of reserve capacity set by a futures contract. The same strategy could be (such as a swap or ) when reinvesting its the North American Electric Reliability applied if the put was undervalued. The ability to Risk policies and procedures coupon payments and principal repayments. Corporation that needs to be on the accounting undertake this riskless arbitrage relies on put-call The fundamental control documents in most books of an electricity utility. It has to have a parity. corporate risk management programmes. Relative performance option certain specified amount of capacity above the H see also box, conversion An option giving the buyer the right to the utility’s peak requirements, which are calculated Roll-lock swap return from a single asset from a basket of using probabilistic models. Rho A swap that enables futures traders to lock- two or more, either as a cash settlement or by A measure of an option’s sensitivity to a change in their roll-over costs by paying the average physical delivery. The asset selected may be Reserves in interest rates; this will affect the future price of difference between near and far contracts. the best- or worst-performing of the assets in Back-up power that must be made available the option and the time value of the premium. Its the basket, as measured against a common or at all times to meet fluctuations in system impact increases with the maturity of the option. Roll-over clause independent benchmark. demand within a given range, to ensure smooth, A clause in a contract that allows the contract continuous delivery of energy at proper voltage Risk-adjusted return on capital (Raroc) to be extended beyond the initially agreed Renewable energy and current levels. A technique of risk analysis that assumes a higher termination date. Any form of energy that is replaced by nature, return for a riskier project than a less risky one. with or without human assistance. Common Residual fuel oil Roll-over risk forms of renewable energy include wind, solar, Heavy fuel oil produced from the residue in the Risk capital The risk that a derivative hedge position will geothermal and tidal energy. fractional distillation process rather than from Funds at risk in a company or trading business. be at a loss at expiration, necessitating a cash the distilled fractions. payment when the expiring hedge is replaced Replacement cost Risk management with a new one. The replacement cost of a financial instrument Retail sales Control and limitation of the risks faced is its current market value. In credit risk terms, Sales made directly to the customer that by an organisation due to its exposure to Rotterdam market it is the cost of replacing a given contract if the consumes the energy product. changes in financial market variables, such as A term sometimes used to describe the oil market counterparty defaults. foreign exchange and interest rates, equity in northwest Europe. There is no Rotterdam Retail wheeling and commodity prices or counterparty trading floor, as oil business is transacted Replication The use of gas or electricity transmission creditworthiness. It may be necessary because electronically, by telephone or on the futures To replicate the payout of an option by buying or facilities to ‘wheel in’ energy from various of the financial impact of an adverse move in markets in New York, London or Singapore. selling other instruments. In the case of dynamic suppliers to local customers. the market variable (market risk); because the replication, this involves dynamically buying organisation is ill-prepared to respond to such a Round-trip trade or selling the underlying (or futures, where Reuters move (operational risk); because a counterparty An outlawed trade in which two counterparties transaction costs are cheaper) in proportion to an Thomson Reuters is a leading source of news defaults (credit risk); or because a specific contract non-competitively trade the same futures option’s delta. In the case of static replication, the and information for businesses and professionals. is not enforceable (legal risk). contract of the same delivery month. The central option is hedged with a basket of standard options Market risks are usually managed by hedging characteristic of a wash sale is the intent to avoid NOTwhose composition FOR does not change withREPRODUCTION time. Reverse crack NOTwith financial instruments, FOR although a firmREPRODUCTION may making or taking a bona fide market position. The sale of crude oil against the purchase of also reduce risk by adjusting its business practices Also known as wash trade. Repo agreement the refined products. In futures trading, it is the (see natural hedge). While financial derivatives To buy (or sell) a security while at the same simultaneous sale of crude oil futures versus the lend themselves to this purpose, risk can also be RTOs time agreeing to sell (or buy) the same security purchase of heating oil and gasoline futures. reduced through judicious use of the underlying H see regional transmission organisations at a predetermined future date. The price of the assets – for example, by diversifying portfolios.

★ ★ ENERGY RISK GLOSSARY 2 0 1 1 ENERGY RISK GLOSSARY 2 0 1 1 COMMODITY RISK MANAGEMENT & TRADING COMMODITY RISK MANAGEMENT & TRADING

Seasonality Seller’s nomination contract Short All commodity futures markets are affected (Gas) The seller nominates the amount of gas The seller of a financial contract. to some extent by an annual seasonal cycle or it expects to deliver in a range around the S ‘seasonality’. This cycle of pattern refers to the estimated daily contract quantity. The buyer Short position tendency of market prices to move in a given is obliged to take or pay for the nominated A position that increases in value if the value Sale for resale direction at certain times of the year. quantity on a daily basis. of the underlying instrument or market price A type of wholesale sales covering energy decreases in value. supplied to other electric utilities, municipalities Secondary CDM market Sell side and federal or state electric agencies for resale to The that encompasses all The financial institutions whose primary Short ton ultimate consumers. subsequent transactions following the primary business is market analysis and trading and who A measure of weight used in the coal industry. sale within the Clean Development Mechanism. sell financial assets to buy-side institutions. Equal to 0.9072 tonnes. Sarbanes-Oxley Act (SOX) H See also Clean Development Mechanism. US legislation enacted in response to the SERC Shrinkage accounting and corporate scandals of 2001– Securitisation SERC Reliability Corporation – a North 1) Gas losses in the transportation and 2002, including ’s collapse. The Act The packaging of assets (normally debt of American Electric Reliability Council within distribution systems. was named after Senator Paul Sarbanes and some description) into securities. These may be the Eastern Interconnection. 2) Gas volume lost through the extractions Representative Michael Oxley and is arranged higher-yielding and more freely tradable than of liquid gases and the removal of water and in 11 titles. Compliance with provisions of the the unpackaged assets. Securitising production Settlement risk other impurities. Act is mandatory. The Sarbanes-Oxley Act of revenues has become increasingly popular The risk that arises when payments are not 2002 established the duties of a firm’s board of among commodity producers over the past exchanged simultaneously. The simplest case is Shrinkage allowance directors, as well as advising on auditing and few years. Electricity utilities have also started when a bank makes a payment to a counterparty The percentage of gas expected to be lost other business requirements. The Sarbanes-Oxley securitising their retail revenue. but will not be recompensed until some time during the transportation and distribution of gas. Act of 2002 is generally considered the single later; the risk is that the counterparty may default most important piece of legislation affecting Security-based swap before making the counterpayment. Settlement Singapore Exchange (SGX) corporate governance, financial disclosure, and Swaps that are based on (i) a narrow-based risk is most pronounced in the foreign exchange The SGX was established in 1999 by the merger public accounting since the US securities laws index of securities including any interest markets, where payments in different of the Stock Exchange of Singapore and the enacted in the 1930s. The Act is often referred therein or on the value thereof; (ii) a single take place during normal business hours in their Singapore International Monetary Exchange. to variously as SOX, S-O or SOA. security or loan, or on the value thereof; or respective countries and can therefore be made It is the Asia-Pacific’s first demutualised and (iii) the occurrence or nonoccurrence of an up to 18 hours apart, and where the volume integrated securities and derivatives exchange. Scenario planning event relating to a single issue or the issuers of of payments makes it impossible to monitor A methodology that attempts to build plausible securities in a narrow-based security index, if receipts except on a delayed basis. This type of Skew views of a small number of different possible the event directly affects the financial statements, risk afflicted counterparties of Germany’s Bank Skew is a measure of the asymmetry of a futures for an organisation operating in condition or obligations of the issuer. Herstatt in 1974, which closed its doors between distribution. A perfectly symmetrical distribution conditions of high uncertainty. receipt and payment on foreign exchange has zero skew, while a distribution with positive Security-based swap dealer contracts. As a result, settlement risk is sometimes (or negative) skew is one where outliers above Scheduling co-ordinator Any person who holds themselves out as a called Herstatt risk. (or below) the mean are more probable. An An entity certified by California’s independent dealer in security-based swaps; makes a market H see also credit risk example is the distribution implied by the system operator to provide schedules for in security-based swaps; regularly enters into presence of a volatility skew between out-of- electricity deliveries within the state’s market. security-based swaps for their own account in Shipper the-money call and put options. NOT FOR REPRODUCTIONthe ordinary course of business; or engages in NOTA company that FORtransports gas along REPRODUCTIONa pipeline Seasonal supplies activities causing the person to be commonly system. Shippers need to be registered with the Supplies of gas used for winter demand. This known as a dealer or in security- local regulatory body. In UK gas market terms, a often includes gas from storage systems. based swaps. shipper is a company that buys gas ‘at the beach’ and pays Transco to transport the gas along the pipeline system.

★ ★ ENERGY RISK GLOSSARY 2 0 1 1 ENERGY RISK GLOSSARY 2 0 1 1 COMMODITY RISK MANAGEMENT & TRADING COMMODITY RISK MANAGEMENT & TRADING

Sleeving Spark spread Spinning reserves Standard deviation A transaction whereby two counterparties The difference between the price of electricity Any back-up energy production capacity that Statistical measure of the degree to which an that do not have credit with each other, ask a sold by a generator and the price of the fuel can be made available to a transmission system at individual value in a probability distribution third party that has credit with both to be a used to generate it, adjusted for equivalent 10 minutes’ notice and can operate continuously tends to vary from the mean of the distribution. middleman to facilitate a trade. This practice units. The spark spread can be expressed in for at least two hours once it is brought online. Indicates probability of a variable or price falling achieved some notoriety in 1998, when it dollars per megawatt hour ($/MWh) or dollars within a certain band around the mean. emerged that the collapsed US power marketer per million British thermal units ($/mmBtu) or Spot cargo Power Company of America had been regularly other applicable units. To express it in $/MWh, A cargo that is available for immediate loading. Standard European coal agreement sleeving forward electricity deals. the spread is calculated by multiplying the The standard European coal agreement is price of gas, for example (in $/mmBtu), by the Spot market a physical contract for coal delivered free- SMES heat rate (in Btu/kilowatt hour), dividing by In the energy sector, the spot market is the on-board into the Amsterdam-Rotterdam- H see superconducting magnetic energy storage 1,000 and then subtracting the electricity price physical/cash crude, refined product, gas or Antwerp area. It is traded in contracts (lots) of (in $/MWh). Also called a spark arbitrage. electricity market. The market for immediate 5,000 tonnes for delivery and priced at 6,000 SO2 delivery rather than future delivery. kilocalories per kilogram. Sulphur dioxide. Special entity Although it is primarily a physical contract, A federal, state or municipal agency employment Spot price counterparties have the option, where mutually SO2 allowance trading benefit plan or an endowment. The price of a security or commodity in the agreed, to close out the position should neither Allowance trading is the centrepiece of the cash market. party want to make or take delivery of the coal. US Environmental Protection Agency’s acid Specific gravity rain programme. Allowances are the currency The ratio of the mass of a given volume of liquid Southwest Power Pool (SPP) Standard market design with which compliance with SO2 emission at 60° Fahrenheit to the mass of an equal volume A North American Electric Reliability Council Designed by the Federal Energy Regulatory requirements is achieved. They authorise a unit of water at the same temperature. This is used to within the Eastern Interconnection. Commission, in light of market manipulation within a utility or industrial source to emit calculate the American Petroleum Institute gravity. of energy prices, to standardise all US wholesale one US ton of SO2 during a given year or any H see also API gravity SPR power markets. year thereafter. H see strategic petroleum reserve Utilities that can use high-sulphur coal – Specific risk Static replication which commands a lower price per British Specific risk is the portion of a security’s market Spread H see dynamic replication thermal unit than low-sulphur coals – can buy risk that is unique to that security. For example, The difference between the bid and ask price. an SO2 allowance and bundle it with a high- the risk that an individual stock’s price may vary Liquid markets are characterised by narrow bid/ Stochastic process sulphur coal purchase to produce more energy. because of its industrial sector rather than the ask spreads. A stochastic process is one that can be broader equity market. described by the evolution of some random Sour crude Spread option variable over some parameter such as time. Crude oil containing a relatively high Speculation An option written on the differential between One example is geometric Brownian motion, percentage of sulphur by weight, typically more The opposite of hedging. The speculator the prices of two commodities. Spread options which is commonly used to describe the than 0.5%. holds no offsetting cash market position and may be based on the price differences between movements of asset prices. deliberately incurs price risk in order to reap prices of the same commodity at two different Sour gas potential rewards. locations (location spreads); prices of the same Natural gas with a high sulphur content that commodity at two different points in time The Black-Scholes model of option pricing requires treatment before use. Speculative position limits (calendar spreads); prices of inputs to, and assumes stock prices follow geometric Brownian NOT FOR REPRODUCTIONA limit on the size a single trader’s position for NOToutputs from, a productionFOR process (processingREPRODUCTION motion with constant volatility and interest rates. SOX a particular commodity. Positions that qualify as spreads); and prices of different grades of the But the assumption of constant volatility fails for H see Sarbanes-Oxley Act bona fide hedges do not fall within the position same commodity (quality spreads). real markets, prompting a number of attempts to limits. Position limits can be for a single-month model volatility as a stochastic process. The most SOx position (a spot month) or for an all-months- notable of these is the Heath-Jarrow-Morton H see sulphur oxides combine position. framework.

★ ★ ENERGY RISK GLOSSARY 2 0 1 1 ENERGY RISK GLOSSARY 2 0 1 1 COMMODITY RISK MANAGEMENT & TRADING COMMODITY RISK MANAGEMENT & TRADING

Storage capacity Strangle Sulphur oxides (SOx) Swap The amount of gas that can be stored to cover An options position consisting of the purchase Gases formed principally by the burning of fossil An agreement that, by its terms, settles financially peak demand. The main types of storage (apart or sale of put and call options that have the fuels containing sulphur, such as coal and oil. and that, in most cases, involves an exchange of from pipeline storage) are: same expiration, but different strike prices. Sulphur oxides such as sulphur dioxide (SO2) fixed-for-floating payments based on the value 1) Liquefied natural gas – gas cooled until in and sulphates are pollutants that contribute to of a notional quantity of a commodity. liquid form at -162° Celsius and stored in Strategic petroleum reserve (SPR) the formation of smog. Since SO2 dissolves in insulated metal tanks. Stockpiles of crude oil owned and controlled by water vapour to form acid and interacts with Swaption 2) Salt cavities (caverns) – many cavities have been the US government. The SPR exists to protect other gases in the atmosphere to form sulphates An option to buy (call option) or sell (put created underground by dissolving layers of salt. the US from the effects of interruptions in the and other products that can be harmful to the option) a swap at a future date. 3) Aquifers (porous rocks). supply of oil and can only be accessed by order environment, ambient air-quality standards have 4) Depleted gas fields now converted into of the US President. As of March 2011, the SPR been adopted in many areas to regulate sulphur Swap data repository storage facilities. consisted of around 727 million barrels of oil oxides emissions. An entity that is governed by the Commodity stored in underground salt caverns along the H see also nitrogen oxides Futures Trading Commission facility for swaps. Storage gas coast of the Gulf of Mexico. Gas kept in storage in order to balance supply Sunshine option Swap dealer and demand over time. Stress testing A corollary to the precipitation swap, this Any person who holds themselves out as a To stress test is to simulate an extreme market instrument is linked to the number of hours of dealer in swaps; makes a market in swaps; Storage manager event and examine what happens to prices sunshine. The party taking out a sunshine option regularly enters into swaps for their own account A company operating a storage facility where under the ‘stress’ of that behaviour. would be compensated if the number of hours in the ordinary course of business; or engages in gas can be stored during periods of low demand of sunshine fell below a certain level. activities causing the person to be commonly for use in times of greater demand. Strike price H see also weather derivatives known as a dealer or market-maker in swaps. The price at which the underlying futures Straddle contract is bought or an option is exercised. Also Superconducting magnetic energy The combination of a put and a call option called an exercise price. storage (SMES) A trading system or platform in which multiple with the same expiration date and strike price. A method of storing energy within a participants have the ability to execute and A buyer of a straddle hopes the volatility of the Structured note superconducting magnetic field. trade swaps. A designated contract market is underlying prices will increase, thereby creating An over-the-counter product, which may not a swap execution facility. Swap execution profit opportunities. incorporate several individual instruments – Supply point nomination facilities are subject to data standards and core generally options embedded in a debt The nomination a gas shipper gives the principles as defined by the Commodity Futures Stranded cost recovery instrument, such as a medium-term note. The pipeline owner when the shipper signs up a Trading Commission. During the period of power deregulation in aim is generally to construct a payout profile new customer. The pipeline owner then works the late 1990s and early 2000s, many electricity that is attractive to a specific investor or group out the charge for transporting gas to the new Swaps push-out rule utilities in the US have tried to recover stranded of investors, because of their risk-reward supply point. Once the shipper accepts this H see Lincoln Amendment costs by pushing their state government to preferences and/or opinions on the market. charge, he takes responsibility for transportation impose a tariff charge on all the state’s electricity charges to that supply point. Sweet crude consumers to pay for stranded costs. This process Structured transaction Crude oil containing a relatively low percentage is known as stranded cost recovery. Non-standard contracts not associated with Suspended rates by weight of sulphur – typically less than 0.5%. owned or leased assets and involving tailoring of New rates that have been accepted by the Stranded costs terms to fulfil client needs. Federal Energy Regulatory Commission Swing NOTThe costs accumulated FOR by electricity utilitiesREPRODUCTION NOT(FERC) but are FORnot yet effective. The REPRODUCTION FERC Variations in gas demand. that have built expensive power plants and can suspend rates up to five months. entered into high-priced power purchase Swing factor agreements, which are no longer commercially In gas purchase agreements, the swing factor is a viable when competition forces prices down measure of the flexibility to vary nominations and and reduces market share. is expressed as a ratio of peak to average supplies.

★ ★ ENERGY RISK GLOSSARY 2 0 1 1 ENERGY RISK GLOSSARY 2 0 1 1 COMMODITY RISK MANAGEMENT & TRADING COMMODITY RISK MANAGEMENT & TRADING

Swing option System operator Tariff Third-party access (TPA) The right to take more or less of a specified A body responsible for operating and Public schedules detailing utility rates, rules, Where the owner of a pipeline or electricity commodity. The opportunity to swing up is maintaining the physical electricity network. For service territory and terms of service that are network is obliged to transport gas, crude or effectively a call option on the commodity the US, see independent system operator. filed for official approval with a regulatory agency. electricity in a non-discriminatory way – i.e., specified in the contract, and the opportunity to for any third party at the same rate as all other swing down is a put option on the commodity, System price Technical analysis users. Third-party access can either be regulated subject to obligations to take certain quantities The benchmark price for all electricity sold Technical analysis is based on the assumption by a separate agency or law, or negotiated over the entire life of the contract. Swing options within an integrated grid system, calculated that price takes into consideration all factors that between the incumbent and the new entrant. are most commonly used in the gas market. on the basis of all transactions within the could influence the price of the commodity. It Also called common carriage. area disregarding price fluctuations caused is therefore broader than fundamental analysis, Swing producer by bottlenecks. The system price is used as a which looks at supply and demand. Past price Tick A company or country that changes its crude oil reference for financial settlements. movements can be analysed for indications of The minimum price movement of a financial output to meet fluctuations in market demand. H see also area price future commodity price movements. contract, expressed in fractions of a point. Saudi Arabia is seen as the world’s major swing H see also fundamental analysis producer, as it deliberately limits its crude oil Systemic risk Time decay production in an attempt to keep supply and The risk that the financial system as a whole Technical rally H see theta demand roughly in balance. may not withstand the effects of a market crisis. A short rise in commodity futures prices within In recent years, attention has been focused on a general declining trend. Such a rally may result Time charter Swiss Electricity Price Index (Swep) emerging derivatives markets, where a handful from bargain hunting by market participants Charter party agreement for a fixed period of Launched in 1998, Swep was the first electricity of players dominate trading. The concern is that or because technical analysts have noticed a time instead of for a certain number of voyages. index in continental Europe. It is based in the the failure of any of these might have serious particular support level at which the commodity In this type of agreement loading and unloading Swiss town of Laufenburg, a major hub for power and widespread consequences for others in the price is expected to increase. costs are not usually included in the charter rate. supplies between Switzerland and Germany. market. The economic crisis and credit market contraction that developed in 2008 raised Technical sign Time value Syndication of risk concerns about financial institution collapses and A significant short-term trend identified Part of the option premium that reflects the A method of splitting risk among several resulting systemic risk. through technical analysis of a commodity’s excess over the option’s intrinsic value, or the counterparties. price movement. entire premium, if there is no intrinsic value. At given price levels, the option’s time value will Synthetic credit rating Tenor decline until expiration. An internal rating based on factors that are The time to maturity of an asset, liability, trade, H see also entrinsic value deemed the most important for establishing transaction or portfolio. counterparty credit quality. T Title Transfer Facility (TTF) Take or pay Terawatt (TW) A virtual trading point for natural gas in the Synthetic option In a buyer’s contract, take or pay is the obligation 1,000 gigawatts (1 trillion watts). Netherlands, created in 2003 by Gasunie in Also known as portfolio insurance, this is a to pay for a specified amount of gas, whether order to facilitate trading in the Dutch market. technique for replicating an option payout by this amount is taken or not. Depending on the Terawatt hour (TWh) buying or selling the underlying or futures contract terms, under-takes or over-takes may be 1,000 gigawatt hours. TOE contracts in proportion to movements in the taken as make-up or carry-forward into the next Tonnes of oil equivalent. theoretical option’s delta. Essentially, it is delta contract period. When it is credited into another Therm NOThedging with nothing FOR to hedge. Those REPRODUCTION trying to contract period, this is called make-up gas. NOTThe imperial unit FOR of measurement for REPRODUCTIONa quantity Tokyo Commodity Exchange replicate a long option position lay themselves H see also make-up gas of gas, equivalent to 100,000 British thermal units. The exchange that regulates trading of futures open to increases in market volatility, but benefit contracts and option products of all commodities if volatility declines. Synthetic replication is Tapis Theta in Japan. It offers futures contracts on precious generally used if implied volatility of options is A crude oil produced in Malaysia and used as a Option risk parameter that measures the speed and industrial metals, oil-related energy products thought to be too high. reference crude for Far East light oil. of time decay of the option premium. and rubber, as well as options on gold futures.

★ ★ ENERGY RISK GLOSSARY 2 0 1 1 ENERGY RISK GLOSSARY 2 0 1 1 COMMODITY RISK MANAGEMENT & TRADING COMMODITY RISK MANAGEMENT & TRADING

Tolling agreement Transco A processing agreement for the conversion of US industry jargon for transmission facilities, or an input product for a fee. In the energy sector, for a company engaged almost exclusively in the tolling agreements are contracts where one provision of transmission service. U V party – the toller – provides a company with one form of fuel to be converted into another Transmission Unaccounted-for gas Value-at-risk form of fuel on their behalf. In particular, in the Moving bulk energy products from where they Gas lost through leakage or errors in The value-at-risk (VaR) of a portfolio is the liquefied natural gas (LNG) industry, tolling is are produced to distribution lines that carry measurement. worst loss expected to be suffered over a given a common method for financing liquefaction energy products to the customers. period of time with a given probability. The plants or regasification terminals. In the former Unbundling time period is known as the holding period, case the tollers are natural gas owners who Transmission facility The separating of the various components and the probability is known as the confidence wish to convert their natural gas into LNG for Equipment used to deliver power at high of electricity production, supply and service, interval. VaR is not an estimate of the worst transportation and storage purposes, in the latter, voltages in bulk quantity, from generating in order to introduce greater elements of possible loss, but the largest likely loss. For the tollers are LNG owners who wish their facilities to local distribution facilities, for final competition to these segments of the industry. example, a firm might estimate its VaR over LNG to be converted into gas for distribution retail use. ‘Functional unbundling’ would require 10 days to be $100 million, with a confidence into the relevant end-market. In the electric H see also distribution monopolistic utilities to provide access to interval of 95%. This would mean there is a power market, tolling agreements are typically their transmission and distribution network one-in-20 (5%) chance of a loss larger than between a power buyer and a power generator, Transmix in exchange for an access fee. ‘Structural $100 million in the next 10 days. under which the buyer supplies the fuel and A by-product of refined petroleum products unbundling’ would require complete vertical In order to calculate VaR, a firm must model receives an amount of power generated based on pipeline operations. Transmix of refined disaggregation, so that monopolistic utilities both the way the relevant market factors will an assumed heat rate at an agreed cost. petroleum products is created by the mixing would be required to divest either their change over the holding period and the way, (co-mingling) of different specification products generation assets or their transmission/ if any, these changes are correlated between Tonne during pipeline transportation. distribution assets. market factors. It must then evaluate the A unit of measure that represents the potential effects of these changes on its portfolio measurement of mass equal to 1,000 kilograms, Transportation capacity Underlying at the desired level of consolidation (by asset or 2204.6226 pounds. The capacity of the UK natural gas system, The variable on which a futures, option or other class, group or business line, for example). which is assessed by the National Grid in three derivatives contract is based. H see also credit value-at-risk TPA places: H see third-party access 1) The entry capacity at the entry to the Upside/downside risk Vanilla option National Transmission System (NTS). A short forward position taken without A standard transaction that is not tailored to the Trading around assets 2) The exit capacity at the NTS offtakes. an offsetting long physical position in the needs of either party. A plain-vanilla option pays Used in tandem with hedging, this activity 3) Local distribution zone (LDZ) capacity underlying commodity is said to have upside out the difference between the strike price of involves selling more production or buying back within the LDZs. risk. This means the trader is speculating that the the option and the spot price of the underlying more volumes than are currently hedged. price of the commodity will decline. at the time of exercise. Trigger condition A long forward position taken without H see also exotic option, option Trading facility The payout of path-dependent options, such as an offsetting short physical position in the A person who provides a physical or barrier options and digital options, depends on underlying commodity is said to have downside VaR electronic facility or system in which multiple a specified market variable satisfying a specific risk. This means the trader is speculating that the H see value-at-risk participants can execute trades or transactions trigger condition. The most common condition price of the commodity will increase. NOTby accepting bids FOR and offers made byREPRODUCTION other is that the spot rate (or price) of the underlying NOT FOR REPRODUCTIONVariance market participants. must trade through a specified level before the Upstream A measure of volatility, risk or statistical dispersion. option becomes active (or inactive), but many Oil and gas exploration and production, as It is the square of the standard deviation. Train (liquefaction) other types of condition are possible. opposed to downstream, which refers to the Liquefied natural gas production units; H see also corridor option, range binary areas of refining and marketing. Variance-covariance liquefaction facilities. H see also downstream Linear value-at-risk.

★ ★ ENERGY RISK GLOSSARY 2 0 1 1 ENERGY RISK GLOSSARY 2 0 1 1 COMMODITY RISK MANAGEMENT & TRADING COMMODITY RISK MANAGEMENT & TRADING

Variation margin Volatility Volatility term structure The margin on a derivatives contract whose A measure of the variability of a market The term structure of volatility is the curve value varies in line with levels of volatility in factor, most often the price of the underlying depicting the differing implied volatilities of the market. The higher the fluctuations in daily instrument. Volatility is defined mathematically options with differing maturities. The term W prices, the higher the variation margin. as the annualised standard deviation of the structure is curved, because the volatility natural log of the ratio of two successive prices. implied by short-dated option prices changes WACC Vega The actual volatility realised over a period of faster than that implied by longer-term options, H see weighted average cost of capital Option risk parameter that measures the time (the historical volatility) can be calculated but other effects, such as mean reversion, may sensitivity of the option price to changes in the from recorded data. also play a part. Wacog price volatility of the underlying instrument. Volatility is one of the variables that must be H see also implied volatility Weighted average cost of gas. specified in the Black-Scholes model of option Vertical disaggregation pricing: a vanilla option will cost more when Volatility trading War premium H see divestiture volatility is high than when it is low. However, Trading, usually through the options markets, A price that factors in the risk associated with volatility is the only one of these variables based on the belief that implied volatility will war – particularly relevant for the oil market. Vertical spread whose value must be estimated. not match the volatility actually realised over a An option strategy relying on the difference The estimate used (known as the implied given period, or that the difference in implied in premium between two options that share a volatility) can be derived from the prices of volatility between different options will alter A certificate giving the buyer the right, but not common underlying and maturity but are struck options in the market and the known input over a given period. Options are used because of the obligation, to buy a specified amount of an at different prices. variables. However, the Black-Scholes model their sensitivity to volatility. asset at a certain price over a specified period of H see also call spread, put spread also assumes that volatility is constant, which is time. Warrants differ from options only in that not true. New techniques have been developed Volcker Rule they are usually listed. VIK to cope with volatility’s variability, including Prohibits banking entities from: (a) engaging Verband der Industriellen Energie- und mean-reverting models (such as Garch) and in proprietary trading; (b) investing in or Wash trade Kraftwirtschaft eV, the German association of stochastic volatility models. sponsoring a hedge fund or private equity fund; H see round-trip trade industrial energy users and self-generators. This or (c) entering into certain transactions with association represents the interests of industrial Volatility skew a hedge fund or private equity fund advised, Watt (W) energy users in Germany for whom energy is a The difference in implied volatility between managed or sponsored by the banking entity. Unit of electrical power equivalent to one joule major cost component, with current members out-of-the-money puts and calls. The origins per second. accounting for the majority of industrial energy of the volatility skew are not always clear, Volumetric risk consumption. but factors may include reluctance to write The effect of fluctuations in demand for a Watt hour (Wh) calls rather than puts, sentiment about market product or service on revenue. Unit of electrical energy equivalent to the Viscosity direction, and supply and demand. power of one watt operating for one hour. A measurement of a liquid’s resistance to flow. H see also implied volatility As temperature increases, viscosity decreases. Weather derivatives Volatility smile Forward instruments used to hedge against VLCC If the implied volatility of an option is plotted or speculate on weather. Virtually all the Very large crude carrier – the super-tankers against its strike on a graph, the chart is typically instruments are based on degree days, although used for transporting crude oil that are capable shaped like a smile (less often a frown). This precipitation swaps and sunshine options are of carrying more than 200,000 metric tons. curve is known as the volatility smile. It may among other possible instruments. NOT FOR REPRODUCTIONreflect the fact that out-of-the-money events NOT FOR REPRODUCTIONH see also sunshine option are more common than geometric Brownian motion would predict. This leads to extra value for out-of-the money options. H see also implied volatility

★ ★ ENERGY RISK GLOSSARY 2 0 1 1 ENERGY RISK GLOSSARY 2 0 1 1 COMMODITY RISK MANAGEMENT & TRADING COMMODITY RISK MANAGEMENT & TRADING

Weather-linked bonds contract, the standard contract for short-term Wiener Process Yield curve The payout of weather-linked bonds, power trading across the US. The contract A type of Markov Stochastic process. It A graph of the term structure of interest rates. commonly known as nature-linked bonds, is traded on a trial basis in May 1987 and was refers to changes in value over small time It is usually given in terms of the spot yields on linked to weather conditions. The return on given final approval on July 1991 by the Federal periods. Sometimes, this process is also called bonds with different maturities but the same risk the nature-linked bond is pegged to a suitable Energy Regulatory Commission. Brownian motion. factors (such as creditworthiness of issuer), plotted meteorological index. A trigger level is defined, against maturity. In general, yields will increase which remains active during the exposure Wet gas Writer with maturity and with the riskiness of the debt. period. If this trigger is hit by the index, 1) Methane (dry gas) mixed with other The seller of an option. Yield curves can be plotted for default-free bonds. the issuer of the bond is allowed to default. hydrocarbons. Bonds that may default will fall on another yield Suitable indexes might include rainfall or 2) Gas with a high liquid content, which often WRMA curve at some spread to the default-free curve. temperature. Insurance companies commonly needs to be dried using a dehydration process. The Weather Risk Management Association issue these bonds to hedge against high H see also dry gas is a Washington, DC-based trade association Yield curve option weather damage claims. representing the interests of the global weather An option whose underlying is the shape of Wheeling derivatives market. the yield curve, normally defined as the yield Weighted average cost of capital (WACC) The transmission of electricity by an entity of a longer-maturity bond minus the yield of a The sum of the market returns of each that does not own or directly use the power it WECC shorter-maturity bond. This allows investors to component of a corporate capitalisation, is transmitting. Western Electricity Co-ordinating Council – a take a view on interest rates without taking a weighted by each component’s share of the North American Electric Reliability Council for view on the ’s direction. The value total capitalisation. Wholesale the Western Interconnection. of a call yield curve option appreciates as the Energy supplied by one producer or marketer to curve flattens, whereas a put’s value decreases. Well another for eventual resale to consumers. WTI An opening in the ground made by drilling or H see West Texas Intermediate Yield curve swap boring and from which oil or gas is obtained. Wholesale wheeling A swap in which two interest rate streams are The transmission of gas or electricity to bulk exchanged, reflecting different points on the Wellhead distributors. yield curve. The control equipment placed at the top of the well casing. Wobbe Index Y An index to indicate the interchangeability Wellhead price of fuel gases and is the best indicator of the Year spread Price of natural gas at the wellhead. similarity between natural gas and a specific Spread between two-year contracts. propane-air mixture. Since this index relates Z West Texas Intermediate (WTI) heating characteristics of blended fuel gases, Yield US crude oil used as a benchmark for pricing it can also be used to obtain constant heat The interest rate that will make the net present Z-score much of the world’s crude oil production. WTI flows from gases of varying compositions. The value of the cash flows from an investment equal A statistical measure that quantifies the distance is a relatively low specific gravity ‘intermediate’ Wobbe Index, however, does not relate flame to the price (or cost) of the investment. The net (measured in standard deviations) a data point is crude with low sulphur content (‘sweet’). temperatures, heat transfer co-efficients or present value is the present value of future cash from the mean of a data set. The terminology is temperature gradients. flows, discounted at the present cost of capital. also used to refer to the output from a credit- Western Systems Power Pool (WSPP) The relates the annual coupon strength test that gauges the likelihood of The WSPP is an organisation of more than Working gas yield to the market price by dividing the bankruptcy, also known as the Altman Z-score. NOT300 electricity utilitiesFOR and power marketers REPRODUCTION (US) The amount of gas in a storage facility NOTcoupon by the priceFOR divided by 100, REPRODUCTIONneglecting throughout the US operating under an umbrella above the amount needed to maintain a the time value of money or potential capital Zero-cost option marketing agreement. The WSPP Agreement is constant reservoir pressure (the latter amount is gains and losses. An option strategy under which one option is open to power sellers and customers, though it known as cushion gas). The simple yield-to-maturity takes into bought by simultaneously selling another option provides only for wholesale and not retail sales. account the effect of the capital gained or lost at of equal value. It established the WSPP electricity spot market maturity, as well as the current yield. H see also collar, cylinder

★ ★ ENERGY RISK GLOSSARY 2 0 1 1 ENERGY RISK GLOSSARY 2 0 1 1