Risk Management in Petroleum and Natural Gas Industry: Requirements and Instruments

Derivatives are financial instruments that donot represent ownership rights in any asset but, rather,derive their value from the value of some other underlying commodity or other asset. Derivatives are efficient and effective tools for isolating financial risk and hedging to reduce exposure to risk.Use of derivatives in petroleum and natural gas industry has come about with price deregulation and rapid growth of spot markets. Under industry regulation,energy prices were infrequently changed but, stable prices were paid for with shortagesin some areas and surpluses elsewhere. Free markets revealed that petroleum and natural gas prices are among the mostvolatile of all commodities. In recent decades,firms operating in petroleum and natural gas industry use derivatives to reduce price flactuations risk, stabilize cash flow and finance investment plans. In this article, we will introduce various kinds of financial derivatives, price risk management methods with derivatives in the petroleum and natural gas industries and assess prerequisites and requirements for developing derivatives in energy industry.