Key Papers in Commodities Finance

February 25, 2010

I have compiled a list of some of the most important and influential papers and models, as an introduction to commodities finance or for those involved in modelling commodities (oil, gas, electricity, metals and agricultural products). It is not exhaustive; it is intended as a guide to ‘where to get started’.

Version 1.4 (PDF)


Parameter Estimation : Mean Reverting Process

February 24, 2010

I’ve recently been calibrating some oil and gas models, which involved parameter estimation of the well-known Ornstein Uhlenbeck mean reverting process.
I found that it’s very hard to accurately calibrate the mean-reverting-strength parameter of the model, so I looked into this in some more detail, including simulations and Matlab code to simulate and estimate the process, using both Maximum Likelihood and Least Squares estimation techniques, and I’ve documented it here (PDF).

Presentation : Introduction to Commodities Modelling

February 11, 2010

I gave a presentation (PDF) earlier in the week to some past students of the Wilmott CQF course which I took myself back in 2008. The topic was ‘Introduction to Commodities Modelling’.

The audience members were mainly finance professionals (both in London where I gave the talk, as well as various other financial centres where people logged in to watch online). Typical CQF graduates are very good at mathematical finance with strong commercial experience of equities/interest rates/credit products, so I was “talking to the converted”.

The aim was to give a flavour of commodities as an asset class, show how each commodity is different and to cover some of the modelling tools that can be used depending on the problem, such as Geometric Brownian Motion, mean reverting processes, regime shifts, spike modelling, seasonality, the ‘convenience yield’ concept, etc.

The presentation I gave is here (PDF) (with slight modifications – I’ve improved the presentation slightly since I gave the talk).

Recommended Paper – Oil and Gas Depletion

February 5, 2010

I’ve been reading a lot of material recently on resource depletion, and specifically on the oil and gas industries.  You’ve no doubt heard some people saying “we’re fast running out of oil”, others saying “we had 30 years oil left in 1970, and we still do today” and such seemingly contradictory statements.

What’s the truth of the matter?  It’s an extremely complex area.  So a paper that gives a summary of the situation is very welcome.  The best I’ve found so far is this paper by R.W. Bentley of the Oil Depletion Analysis Centre, London, UK, entitled “Global oil & gas depletion: an overview” (2002).

Mr Bentley first covers some definitions because there’s lots of difficulties with definitions, units, categories etc in this field.  What is oil?  How do we classify heavy oils, oil shales, natural-gas-to-liquid technology and so on, what is a P50 forecast, etc…

He then covers the available data, why it’s hard to get and why there’s no single ‘definitive’ database of oil wells, discoveries etc. In particular, we know that OPEC’s data, the most important because it covers the most oil, is also probably the least trusted, because of some very suspicious changes to oil reserves in the 1980’s (for some technical and political reasons, most OPEC countries doubled their stated oil reserves ‘overnight’ during the 1980’s).  Now nobody knows what is really true.

Bentley then looks at the various alternatives to ‘conventional oil’.  He covers various  estimates of how much is available, both remaining undiscovered, in existing known reserves, and already consumed (the so called URR or ultimately recoverable resource).  He then looks at various depletion models (what happens to production over time, especially what happens as resources dwindle) and likely shapes of the production curve.  This is one of the key issues.  He covers the people making the major forecasts and their background, including a section on the legendary ‘Hubbert’ predictions.  Finally he draws his own forecast, placing ‘peak oil’ at around the current day (2010).  Bear in mind this prediction was made in 2002, but the paper is barely dated.

In summary, R.W. Bentley’s paper is a great introduction to a very complex topic.


Bentley, R. W. 2002. Global oil & gas depletion: an overview. Energy Policy 30, no. 3 (February): 189-205. doi:10.1016/S0301-4215(01)00144-6.

Recommended Paper – Introduction to the Oil Markets and Oil Prices

February 4, 2010

I’ve started a new section recommending some of the best papers I’ve read on commodities and energy.

The first entry goes to this paper by Fabian Kesicki of the Energy Institute, UCL, University of London, entitled ‘The third oil price surge – What’s different this time?

In a well written 11 pages Fabian covers all the basics of the modern oil market as well as the history of oil in the 1970’s, when the previous two ‘oil shocks’ happened.  He covers in detail demand factors that affect the price of oil (GDP and energy intensity, substitutability of other energy sources) as well as production issues (capacity constraints, investment, various major discoveries, reserves ‘growth’ etc).  He also looks at refining issues, discusses the different types of crude oil as well as the major uses of oil, and what this means for refineries.  He manages to cover geopolitics, looking at OPEC (as you’d expect) and the effect of OPEC’s varying pricing power over time.  He even covers the role (large or otherwise) of speculators in high oil prices, and finishes by examining the effect of the US dollar exchange rate on oil prices.

In conclusion, if you want to read one paper and learn a vast amount about the oil industry and oil prices since the 1970’s, read Fabian Kesicki’s paper.  His paper covers an amazingly wide range of issues, without dwelling excessively anywhere.  I have not read a better summary of the world oil markets.


Kesicki, Fabian. 2010. The third oil price surge – What’s different this time? Energy Policy 38, no. 3 (March): 1596-1606. doi:10.1016/j.enpol.2009.11.044.