Davis W. Edwards - Energy Trading and Investing

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In the seven years since I wrote the first edition, lots of things have changed. Ive received a lot of feedback about the original edition, and there have been many dramatic changes in the energy markets. For this edition, I substantially expanded the coverage of oil markets, added more mathematical discussions, and provided clear-English descriptions on some of the less documented parts of the energy markets. I also substantially expanded the discussions on mark-to-market accounting, hedging, and risk management. I kept the same structure as the original bookbroad discussions at the beginning of the book followed by separate discussions on specific aspects of the energy markets later in the book.

The energy markets have also changed. In the original book, policy makers were very concerned with the world running out of affordable energy. Less than a decade later, those concerns are much less pronounced. Concerns about global warming and carbon emissions are still present, but it is less clear how these concerns should be addressed. Despite having a string of record temperatures, few changes have been driven by legislation or international treaties. Progress has largely been made by the adoption of new technology in free markets.

The first major shift occurred with the development of technology that could be used to free fuel trapped in shale rock formations, called hydraulic fracturing or fracking. Fracking opened up a vast supply of natural gas in the United States. In 2009, when I wrote the first edition, a major concern of the energy market was that rapidly dwindling supplies of fuel would soon lead to imports from other countries. By 2016, fracking was flooding the United States with cheap natural gas. Natural gas terminals constructed to import gas in 2009 were undergoing conversion to export fuel.

This has had a domino effect across other energy markets. First, it drove down the price of electricity since fuel costs are one of the major components of electricity prices. Second, by lowering the cost of natural gas, coal became much less attractive as an electrical generation fuel. This largely achieved the goals of carbon legislation proposed between 2000 and 2010. Finally, fracking triggered a price war in the crude oil markets by raising the possibility that a very large economy (the United States) might transform from a net importer of fuel to a net exporter.

In the future, other technologies could have a similar transformative effect. For example, mobile telephones and tablets have driven down the cost of batteries and low-power video displays. Energy-efficient tablets and phones are replacing energy-hungry televisions and desktop computers at a very fast rate. These technologies are also spilling over into related areas like electric cars and LED lightbulbs. Along with better home insulation, these changes have kept consumer demand for electricity stable for nearly a decade.

It seems likely that technology changes will continue to drive changes in the energy markets for the immediate future. Across the energy industry, change is usually a mix of both good and bad news. With any market change, there will both be winners and losers. However, as an investor, rapidly changing markets provide opportunities unavailable in less turbulent periods.

As always, I am grateful for the support of my wife, Angela, and my two children, Spencer and Brianna. Writing doesnt keep regular hours, and they helped me through the process. I would also like to thank my long-time agent, John Willig, the editor of the second edition, Cheryl Ringer, and the project manager, Dipika Rungta.

Davis W. Edwards

Houston, 2016

The inspiration for this book came early in my energy trading career. Previously, I had traded a variety of other products. However, after the boom years in the stock markets in the 1990s and the real-estate boom in the early 2000s, energy became the hot new area around 2005. A wave of financial professionals, including me, left our previous trading desks to join the hot new energy market. Of course, it wasnt really a new market, but with the fall of Enron and market deregulation, trading opportunities were wide-open and expanding.