Energy prices matter to everyone. Energy is a basic factor of production, and it provides light, protects people from cold and heat, and powers all transportation and modern technology. The energy business is a risky business. In addition to the usual financial and business risks, energy businesses face other risks from accidents, such as those from explosion, fire, or leakages; earthquakes and major storms; war and terrorism; increasing regulation; and expropriation.
The industry consists broadly of fossil fuels and alternative energy. Fossil fuels comprise oil, natural gas, and coal. Although a metal, uranium is treated as part of this industry. The alternative energy industry includes solar, wind, water, biomass; geothermal and fuel cells. Electricity is a secondary source of energy, generally powered by a fossil fuel. These energy sources must be produced, transported, and distributed to consumers non-stop in a global market. Each source requires expensive infrastructure along the entire chain of production and distribution.
Energy markets and the associated derivatives markets are characterized by sudden jumps, reversion to their mean, and price volatility that varies over time. Each source has unique properties and applications leading to its own demand and supply characteristics. In addition, other factors drive price: macroeconomic factors such as economic activity, reserves, the existence of substitutes and their prices; supply chain issues, such as refining capacity, storage capacity, and pipelines or tankers; and geopolitical factors such as war and embargos. The primary energy derivatives are futures, forwards, options, and swaps.
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