Commodity Option Pricing: A Practitioner's Guide

5 Energy I – Crude Oil, Natural Gas and Coal

Fossil fuels such as crude oil, natural gas and coal have been known for thousands of years but have only been used for industrial purposes over the past couple of hundred years. In this chapter we treat all three together, describing their features and then discussing how they trade in the financial markets.

For most of history, crude oil was known as an oozy oily substance that seeped from the ground, of various grades from light oils through to thick tars and bitumens which have been discovered on stone tools used by Neanderthals (so the intelligent use of petroleum deposits actually predates our species). Oil has been in commercial use on an industrial scale since the middle of the 19th century, when oil wells were dug in Europe and North America, initially to provide oil for kerosene and oil lamps. Coal has a somewhat longer industrial history; used by Romans in blacksmithing (Freese, 2006) and certainly from the early days of the industrial revolution (e.g. James Watt’s invention of the steam engine in 1781) to power steam engines and the like. Natural gas, being gaseous, was rather more mysterious. The smell of methane would have been apparent, but lightning strikes would on occasions ignite the gas and lead to the unusual spectacle of burning flames erupting from the rocks. There is conjecture that the eternal flame burning in the inner temple at the Oracle of Delphi was a result of natural gas emanating from Mount Parnassus, ...