1
Financial Instruments for Hedging Commodity Risks
WBI-GWU Conference
Oil Price Volatility, Economic Impacts, and Financial Management: Risk-Management
Experience, Best Practice, and Outlook
Ismail DallaArtit Serngadichaivit
March 10-11, 2008
0.0
500.0
1,000.0
1,500.0
2,000.0
2,500.0
3,000.0
3,500.0
4,000.0
19941995199619971998199920002001200220032004200520062007
Nymex: Futures and Options Trading Volume ('000,000)
Total volume
Futures
Options
Source: Nymex
2
Options vis a vis Futures
Futures
Option
Risks Unlimited risk on long and short positions
Defined and limited on purchase of puts and calls; unlimited on sale
Price Protection Establishes fixed price Establishes floor or ceiling price protection
Margin Required on long or short positions
Futures style margins for sellers, margin contained in the cost of premium for buyers
Hedging Long, short, spread Multiple hedging strategies
Using Exchange Traded Futures for Hedging
-$0.60
-$0.40
-$0.20
$0.00
$0.20
$0.40
$0.60
$2.20 $2.30 $2.40 $2.50 $2.60 $2.70 $2.80 $2.90 $3.00 $3.10 $3.20
Price / Gallon
Prof
it / L
oss
Long Inventory
Short Futures
Final Payout
3
Hedging through Exchange Traded Option(Put Option)
-$25
-$20
-$15
-$10
-$5
$0
$5
$10
$15
$20
$25
$76 $80 $84 $88 $92 $96 $100 $104 $108 $112 $116
Price / Barrel
Prof
it / L
oss
Long Inventory
Long Put
Final Payout
Hedging through OTC Swap (Fixed Price Swap)
$80
$85
$90
$95
$100
$105
$110
$115
$120
$125
$130
1 2 3 4 5 6 7 8 9 10 11 12
Month
$/B
arre
l
Market Price
Sw ap - Realized Price
4
Hedging through OTC Option Price Floor (Insurance)
$80
$85
$90
$95
$100
$105
$110
$115
$120
$125
$130
1 2 3 4 5 6 7 8 9 10 11 12
Month
$/B
arre
l
Market Price
Floor - Realized Price
Hedging through OTC Option
Zero Cost Collars (Price Bands
$80
$85
$90
$95
$100
$105
$110
$115
$120
$125
$130
1 2 3 4 5 6 7 8 9 10 11 12
Month
$/B
arre
l
Market Price
Collar - Realized Price
5
Government Hedging ProgramsMajor Constraints
• limited institutional capacity in implementing a commodity hedging program
• lack of earmarked financial resources to cover margin calls associated with futures contracts
• lack of financial resources to purchase options which require payment of premium
• regulatory restrictions in some countries which prohibit purchase/sale of risk management instruments such as futures andoptions as they are perceived to be speculative; and
• absence of a successful role model of government hedging programs.
Oil Exchange Traded Funds
Oil = IPATH ETN Crude Oil, USO=US Oil Fund ETF, GSPC=S&P 500
6
Government ABC MDBUSD 100 million
Initial Flow
Subsequent Flows
Government ABC MDBCommodity
(fixed volume)
Commodity User
Commodity(fixed volume)
Spot Price
Investment Bank
Spot PriceFixed Price
Role of Multilateral Development Banks
Summary
• The range of hedging instruments for hedging oil risks has increased both on the major commodity exchanges (Nymex and ICE).
• Options are becoming increasingly popular as hedging instruments given their modest cost and ability to participate in upside.
• The use of hedging instruments by emerging market country governments remain limited due to capacity and political constraints.
• Multilateral Developments have an important role to play in capacity building through technical assistance and heding products.
Thank you