What makes energy commodities different from other asset classes?

Many seasoned risk managers in other asset classes consider energy trading as simply more of a “white knuckle” experience than other businesses. This view is often based in part on the empirical observation, easily gleaned from any screen with West Texas Intermediate (WTI) or Brent oil futures prices, that energy commodities can exhibit exceptionally high volatility. The relatively frequent blowups of energy trading desks reinforce the image. Noteworthy instances of abuse of market mechanics, such as in the case of Enron and other power marketers in California in the early 2000s, accompanied by index manipulation in natural gas, and culminating more recently with the Amaranth spectacle and FERC actions against several power marketers, add credence to the notion that energy markets can be challenging environments in which to operate.

Much of this perception, however, is based on very high-level views of the more newsworthy mishaps, with only cursory knowledge of the commercial realities of energy markets and the risk-management practices that are required to run an energy trading operation. Energy markets serve much more of a purpose than simply providing a few well-capitalized hedge funds an arena in which to speculate on the direction of global energy prices. Most trading activity involves balancing variations in supply and demand across time and between locations.