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1 Oil Futures Market Hedging & Price Management June 1, 2014.

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Presentation on theme: "1 Oil Futures Market Hedging & Price Management June 1, 2014."— Presentation transcript:

1 1 Oil Futures Market Hedging & Price Management June 1, 2014

2 2 Outline Types of Financial Instruments Jargons Usages of Financial Instruments Trading Failures

3 3 Types of Financial Instruments Forward Contract Futures Contract Derivatives 1.Options Calls Puts 2.Swaps

4 4 Forward Contract A supply contract between a buyer and seller, whereby the buyer is obligated to take delivery and the seller is obligated to provide delivery of a fixed amount of a commodity at a predetermined price on a specified future date. Payment in full is due at the time of, or following, delivery.

5 5 Future Contract A supply contract between a buyer and seller, whereby the buyer is obligated to take delivery and the seller is obligated to provide delivery of a fixed amount of a commodity at a predetermined price at a specified location.

6 6 Futures Contracts - Characteristics Regulated Small lots Monthly quote Price transparent Clearing house Margin money required Not always physical

7 7 Options a right – but not an obligation- to buy or sell an underlying asset at a fixed price during a specified time period in exchange for a one- time premium payment. Call: the option to buy Put: the option to sell

8 8 Where are They Traded ? NYMEX (US)IPE (London) Light sweet crude (WTI)Brent Heating oil (No 2)Gasoil Gasoline Natural Gas SIMEX (Singapore) Fuel Oil

9 9 Jargons Contango vs. Backwardation Long vs. Short Bull vs. Bear

10 10 Contango If at any point in time… Market prices RISE through future months… Then the market is in CONTANGO

11 11 Backwardation If at any point in time….. Market prices FALL through future months… Then the market is in BACKWARDATION

12 12 IPE Gasoil Curve

13 13 Pay Out Diagram – Long Position Profits as Market rises Losses as Market falls $/bbl Profits $ Losses $

14 14 Pay Out Diagram – Short Position Profits $ Losses $ Profits as Market falls Losses as Market rises $/bbl

15 15 Use of Financial Instruments 1. Speculation 2. Hedging 3. Price Management

16 16 Speculation Outright position taking Pure paper traders Directional price movement

17 17 A Speculative Market

18 18 Hedging Definition: Taking an opposite position on futures to that on physical to remain… PRICE NEUTRAL Objective: TO REDUCE RISK

19 19 Hedging - Example It is October 29 th. A trader loads a gasoil cargo ex-Yanbu. The FOB price is $270/ton. His freight cost is $15/ton. He also has agreed to sell it CIF to a buyer in Rotterdam at Platts 0.2%S CIF on arrival. Vessel is due Rotterdam November 9 th. Today, Platts 0.2%S CIF price is $293/ton IPE December Futures price for gasoil is $291/ton. The trader intend to make $8/ton in profits.

20 20 Hedging – Example (continue) Hedging plan (Part I) When the physical is priced in, he should sell futures (October 29 th ) Action:1. Buy $270/ton 2. Sell $291/ton

21 21 Hedging – Example (continue) Hedging plan (Part II) When the physical is priced out, he should buy futures (November 9 th ) On November 9 th, Platts CIF Cargoes price is $280/ton IPE December Futures price is $278/ton Action:1. Sell $ Buy $278

22 22 Hedging – Example (continue) Physical$/tonFutures$/ton FOB Purchase -270Sell on Oct. 29 th +291 Fright-15Buy on Nov. 9 th -278 CIF Sale280 Net-5Net13 Accounting OVERALL NET = +$8/TON

23 23 Price Management Definition: Using futures and forward markets as a vehicle to… CATCH THE MARKET Objective: LOCKING IN A PRICE

24 24 Price Management - Example It is November 1 st A Japanese refinery is due to load Dubai crude on December 15 th As usual, price will be determined 5 days around B/L Buyer fear that crude prices are increasing next month and would like to lock current price Action:1. Buy Dubai futures now 2. Sell Dubai futures at time physical is priced

25 25 Why Do You See Trading Failures? Failure to understand risk & exposure Poor organizational structure Excessive speculation No position tracking Absence of controls Extreme market volatility

26 26 Crude Oil Prices

27 27 Crude Oil Price Volatility OPEC Meeting (Vienna)

28 28 Summary Many financial instruments Three motives to use financial instruments. There is a distinct difference between hedging and speculation Hedge to reduce risk Trading Failures


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