By Mitchell Zimmer Marshall wins BMO Capital Markets Advanced Research Scholarship
James Marshall’s insights into building mathematical models to study the relationship between commodity costs and the price of energy production have earned him the BMO Capital Markets Advanced Research Scholarship. Marshall is a third year Ph.D. student in the Department of Applied Mathematics whose research proposal entitled “Monte Carlo Methods for Swing Options” was selected along with the work by Waterloo’s Zhenyu Cui to share the $20,000 scholarship. There were a total of nineteen applicants from across Canada.
Monte Carlo methods are a set of equations that rely on repeated large amounts of random numbers in their computations and are useful for modeling situations dealing with risk or uncertainty. The method has numerous applications ranging from physics to business.
Swing options is a term used in energy markets. Since the majority of the energy is produced by commodities such as coal or uranium, the price of energy is tied to the market fluctuations of supply on one hand and the uncertainty of demand for energy on the other. According to Marshall energy suppliers “don’t necessarily know how much demand there’s going to be on the back end from their consumers, so a swing option gets put on top of a regular contract.” The swing option allows the energy producers to buy extra quantities of the commodity at a predetermined price or potentially sell some back if they don’t need all of what has been delivered. So if there is a sudden, unexpected cold snap, the option covers the cost of the additional fuel to meet the increased energy demand.
Since the price is set when the contract is signed, whatever the commodity, the prices can fluctuate during the contract period. So if the price goes up when the swing option is invoked the commodity will be sold at the old price and the commodity dealer will lose money. This is where the Monte Carlo methods come in to determine a fair price to account for the sudden cold snaps or warm breaks. Marshall says that this model will help people to “know how much to pay for a premium up front, there are certain parameters for hedging away the risk for you.”
There was an added surprise benefit when Marshall made his scholarship presentation to BMO. They offerd him a summer internship at the BMO Head Office in Toronto. “I’m really looking forward to it,“ says Marshall. While there he’ll be working at one of the trading desks “Hopefully, I’ll get to move around a bit at some of the different desks to see what they do.”
