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Oil Futures Market

Oil Futures Market. Hedging & Price Management January 7, 2020. Outline. Types of Financial Instruments Jargons Usages of Financial Instruments Trading Failures. Types of Financial Instruments. Forward Contract Futures Contract Derivatives Options Calls Puts Swaps. Forward Contract.

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Oil Futures Market

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  1. Oil Futures Market Hedging & Price Management January 7, 2020

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

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

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

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

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

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

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

  12. IPE Gasoil Curve

  13. Pay Out Diagram – Long Position Profits $ Profits as Market rises 27 28 29 $/bbl Losses as Market falls Losses $

  14. Pay Out Diagram – Short Position Profits $ Profits as Market falls 31 32 33 $/bbl Losses as Market rises Losses $

  15. Use of Financial Instruments • Speculation • Hedging • Price Management

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

  17. A Speculative Market

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

  19. Hedging - Example • It is October 29th. • 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 9th. • 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. Hedging – Example (continue) • Hedging plan (Part I) • When the physical is priced in, he should sell futures (October 29th) • Action: 1. Buy physical @ $270/ton 2. Sell Futures @ $291/ton

  21. Hedging – Example (continue) • Hedging plan (Part II) When the physical is priced out, he should buy futures (November 9th) • On November 9th, • Platts CIF Cargoes price is $280/ton • IPE December Futures price is $278/ton • Action: 1. Sell physical @ $280 2. Buy Futures @ $278

  22. Hedging – Example (continue) Accounting OVERALL NET = +$8/TON

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

  24. Price Management - Example • It is November 1st • A Japanese refinery is due to load Dubai crude on December 15th • 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. 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. Crude Oil Prices

  27. OPEC Meeting (Vienna) Crude Oil Price Volatility

  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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