7/21/2019 Risk Workshop
1/28
2013 Pl atts, McGraw Hill Financial. All rights reserved.
Risk Management Workshop:The Middle Distillate Case
Mr Antonio JulianoManager Risk Data Services-EMEA
September 03, 2013
mailto:[email protected]:[email protected]7/21/2019 Risk Workshop
2/28
Objectives
How to use financial instruments for cargo hedging and risk
management purposes
How Platts Forward Curves help in cargo hedging and risk
management activities
How a trading company manages market risk using swaps
Use of options in hedging
Hedging Case Study
Trading company manages market risk exposure of a middle distillate
cargo (JET A1, ULSD 10ppm) using a mix of futures and swaps
2
7/21/2019 Risk Workshop
3/28
0%
10%
20%
30%
40%
50%
60%
WTI S&P 500 Gold Nat Gas API4 Brent
Volatility
Volatile Nature of Commodity Markets
3
Source: Bloomberg
3-year Historical Implied Annualized Volatility
0%
20%
40%
60%
80%
100%
120%
Nov-08 May-09 Nov-09 May-10 Nov-10 May-11
Volatility
CL1 Comdty SPX Index NG1 Comdty CO1 Comdty
Effective risk management measures are crucial in sectors that experiencehigh volatility, especially in environments where uncertainties reign
3-year Historical Implied Annualized Volatility
7/21/2019 Risk Workshop
4/28
Oil Market Overview
Uncertainties about the global economy still reigns as the EU is
mired in low growth Supply uncertainties still exist in the market
Iran embargo/sanctions
Major disruption in supply from volatile Libya and Nigeria
Demand is slated to increase Refinery startups in Asia and direct burn by the power sector in the Middle East
4Source: IEA Platts 6thAnnual Crude Oil Summit
7/21/2019 Risk Workshop
5/28
Hedging Definition and Objectives
5
Hedging is taking an equal and opposite financial positionon a futures, forward or other derivatives market to that onthe physical market to protect against major adverse pricechanges
To prevent or limit losses To keep within budget
To maintain profit margins
Fix prices ahead
To reduce investment risk
7/21/2019 Risk Workshop
6/28
6
Imperfect Hedging/Basis Risk
Hedging to cancel/mitigate absolute price risk,introducing basis risk
Grade/commodity difference
Jet versus ICE gasoil
Location difference
Amsterdam versus Rotterdam
Timing (calendar) difference
January versus February
7/21/2019 Risk Workshop
7/28
Risk in Trading
7
Price Risk
Counterparty risk: Clients might not want to have a large OTC derivatives
exposure with a single counterparty.
Once a transaction is entered it can be given up to the exchange for
clearing and hence eliminates counterparty risk, i.e. the client will end upfacing the exchange.
Basis/Liquidity risk: physical contracts might be linked to an illiquid
instrument other than the major and/or more commonly used/traded
ones.
Correlation and other statistical analysis can be applied to decide whether it
is feasible to use an instrument as a proxy hedge, i.e. to see how well
correlated each instrument is to each other.
7/21/2019 Risk Workshop
8/28
Rolling Hedges to Overcome Liquidity
8
This strategy works by hedging further dated exposure using the more liquid Brent
crude and then rolling this into jet fuel by buying the crack spread on a closer tenor
On a short term basis the paper hedge is an improved match to the physical fuel that
the airline has to purchase
Hence the short term hedges match underlying physical exposure while the longer
dated ones act as a hedge against general market movements
3-4 years
2 years
1 years
Buy Brent
Swap = Long
Brent
Buy Gasoil Crack
(+ GOBrent)
Buy Jet Diff
( + JetGO)
7/21/2019 Risk Workshop
9/28
Hedging Instrument-Swap
9
An airline is exposed to increases in jet fuel prices and can choose a variety of tools to
hedge depending on its risk philosophy.
The most vanilla product that an airline could utilise is a fixed for floating swap, where
the airline pays a fixed price in return for receiving the floating price.
Hedging Tools Description Benefits Potential Costs
Fixed forFloating Swap
Enables the client to eliminate their price exposure,protecting themselves from a rise in commodity prices.
To do this the client would buy a swap from a Bank andreceives the floating market rate in return for paying afixed price.
No upfront premium
By receiving the floatingmarket price the client nowhas greater control over theircost base
Forgone benefi t fromfalling
prices
Swap Mechanics:
Airline Supplier
Bank
Airline receives fuel from supplier
Airline pays supplier floating
price for fuel- Platts Jet CIF
NWE 1-30 Sept 13
Airline receives the
floating price from
Bank Platts Jet CIF
NWE 1-30 Sept
Airline pays a fixed
price to Bank
7/21/2019 Risk Workshop
10/28
10
Examples of Producer Hedging Strategies
Hedging Instruments: Option Structures
Mostconservative
Mostaggressive
Buy putoptions
Collars Sell swapsSelling call
options
No, or limited
cost
Upside price
participation
limited (strike
of call)
Downside
price
participation
limited (strike
of put)
Defined, upfront
cost, analogous
to buying
insurance
Worse case
future sales
revenue known
at outset
Upside price
participation
unlimited
No upfront cost
Fixed price for
future sites
Full protectionfrom lower
prices
CONSIDERATION
No upside
participation
Maximum
benefit is
upfront premium
7/21/2019 Risk Workshop
11/28
Case Study : Complete Futures and Swaps
11
Purchase from: Antonio Limited Sale to: Juliano Limited
Date oftransaction: 8th March, 2013 Date oftransaction: 09th April, 2013
Type: Spot purchase Type:Spotsale
Quantity: 30,000 MT +/-10 pct vol, buyer's optionQuantity: 30,000MT+/-10pct,
seller's option
Quality:
ULSD 10PPM French summer specs,c&b, bio-free Quality:
USLD 10PPM French summerspecs, c&b
Pricing formula:Platts ULSD 10PPM High CIF MED22 May-12thJune 2013 Pricing formula:
Platts ULSD 10PPM High CIFMED 1-3rd July 2013
Price: 2.00basis 0.8450 Price: -3.75 basis0.8450FreightEstimate:
FreightEstimate: 5.38 basis 27kt
Payment terms:4 working days afterB/L Payment terms: 3/5 COD/NOR
Laytime & Demurrage: 36H +6NOR\ CP
Laytime &Demurrage: 36H +6NOR\ CP
Load/Discharge laycan:
FOB FOS, 20-30th June, buyer to
nominate 3 days (5 days in advance)
Load/Discharge
laycan: CIF Barcelona, 2-5th July, 2013
Shipping condition(s): FOB
Shippingcondition(s): DES
Creditinformation: SBLC
Creditinformation:
opencredit
GTC: GTC:
Law: English Law: English
Broker (if any): Broker (if any):
Deal done by: Deal done by:
7/21/2019 Risk Workshop
12/28
7/21/2019 Risk Workshop
13/28
Hedging and Exposure
13
Exposure is to 10ppm CIFMED High quote
10ppm CIFMED= ICE GO+ premium/discount ( differential) ICE GO flat price hedged using futures and differential hedged using basis swaps
10ppm CIFMED = 1020$/mt i.e. ICEGO=990$/mt+40$mt
Risk Manager will agree exposure and will control that traders buy and sell futures to hedge flatprice in a proper manner
Purchase
Physical
30,000
Futures
300 lots Sale
Physical
30,000
Futures
300 lots
22-May 1,875 19 sell Jun 01-Jul 10,000 100 buy Jul25-May 1,875 19 sell Jun 02-Jul 10,000 100 buy Jul
26-May 1,875 19 sell Jun 03-Jul 10,000 100 buy Jul
27-May 1,875 18 sell Jun
28-May 1,875 19 sell Jun
29-May 1,875 19 sell Jun
01-Jun 1,875 18 sell Jun
02-Jun 1,875 19 sell Jun
03-Jun 1,875 19 sell Jun04-Jun 1,875 19 sell Jun
05-Jun 1,875 19 sell Jun
08-Jun 1,875 18 sell Jun
09-Jun 1,875 19 sell Jun
10-Jun 1,875 19 sell Jun
11-Jun 1,875 18 sell Jun
12-Jun 1,875 19 sell Jun
7/21/2019 Risk Workshop
14/28
Hedging and Exposure
14
Buy Physical Sell Physical
22May-12 June 1-3 July
Buy 300 lots ICE GO Jul futures Sell 300 ICE GO lots Jun futures
1-3 July 22May-12 June
Buy 300 lots spread Jun/Jul
11.25$/mt
Buy Jun futures Sell Jul futures
Physical Flat price 22May-12Jun 1020$ Futures ICE GO June long 22May-12 June
1020$
Physical Flat price 1-3 July 1000$ Futures ICE GO short July 1-3 July 1000$
-20$ +20$
7/21/2019 Risk Workshop
15/28
15
Hedging and Exposure
Spread 300 lots Jun/Jul is essential because it defines the
contango gain, in this case spread Jun Jul was bought at
11.25$/mt giving a gain of 337,500$ (11.25*300lots)
This shows how important is for a trading decision to monitor
the forward curve of the spread Jun/Jul
In case of a market averse condition (backwardation) the Risk
Manager will monitor the spread and at a critical level put
pressure on the trading desk
7/21/2019 Risk Workshop
16/28
16
Hedging and Exposure
Quote 10ppm CIF Med =1020$/m
ICEGO futures+40$/mt differential swaps
Hedging flat price is done throughfutures
Hedging differential 10ppm CIF Med-ICE GO is done through swaps
7/21/2019 Risk Workshop
17/28
17
What happens if when you buy a cargo the differential is X and when you sell
your cargo the differential goes down?
LOSE MONEY
To control differential volatility oil trading companies use swaps or basis swaps
Hedging tool Description Benefits Potential Costs
Fixed for Floating Swap Enables trading desk to
eliminate their price
exposure, protecting
themselves from a rise
in commodity prices
No upfront premium
By receiving the floating
market price, the trader
now has greater control
over his/her cost base
Forgone benefit from
falling prices
Hedging and Exposure
7/21/2019 Risk Workshop
18/28
18
Physical BUY
10ppm ULSD CIFMED-ICE GO
22 May-12 June13
Purchase swap
Buy 40$/mt
SELL 10ppm ULSD CIFMED-ICE GO 22 May-
12 June13
Long40$/mt
fixedpurchase nofluctuation
Physical SALE
10ppm ULSD CIFMEDICE GO
1-3 July
Sale swapBUY 10ppm ULSD CIFMED - ICE GO 1-3 July
Sell ICEGO +43
Short
43$/mtfixed sale
nofluctuation
Hedging and Exposure
7/21/2019 Risk Workshop
19/28
Conclusion
19
Advantages
With futures we locked 355,000$ contango; withouthaving forward curves was not possible to make
this profit
With swaps we locked purchase at 40$/mt and saleat 43 $/mt making 3*30,000=90k
Forward Curves
Look at them and make the decision on when to fixthe sale and purchase
Use them to report PL and MTM
Physical= ICE GO + DifferentialFlat price hedge with ICEGO futures
If you buy physical, you sell futures and vice versaSwaps will fix the differential
7/21/2019 Risk Workshop
20/28
Appendix
Risk Management Workshop: The Middle Distillate Case
7/21/2019 Risk Workshop
21/28
Credit Risk
21
Trade Date 17-June-13
Buyer Antonio Limited
Seller Juliano Limited
Commodity / Product 10PPM fob barges basis ARAless 1stline ICE GO
Price Count Period July - September
Price / Spread 7.00
Quantity 10kt/monthBroker
NotesTullet Prebon
Reference to cargo Speculative Position
With this contract, Antonio buys fixed price 7.00$ and sells 10PPM fob barges basis
ARA-ICE GO 1st
line. If differential goes for Q3 to 12 $/mt and Juliano credit limit is 100K then you would ask
him to pay 50K (5$*30kt =150,000$) into your account without valid forward curves
you cannot control your credit risk
C St d (P d ) H d U i
7/21/2019 Risk Workshop
22/28
Case Study: (Producers) Hedge UsingFutures
22
Scenario
Prices
Hedge Action
We are a Gas Oil producer and are currently seeking GasOil customers for April. It is currently 20thJanuary 2013.
We have very limited storage capacity but potential
customers need to agree April price today. We agree to
sell them 2.000 tonnes at todays April price (plus
operating profit)
Gas Oil Physical Market - $ 140 per tonne
April Gas Oil Futures - $ 141 per tonne
Gas Oil Producer: Buy 20 April Gas Oil Futures
contracts at $ 141
7/21/2019 Risk Workshop
23/28
Hedge - Results
23
25th March
Prices: Cash Market $ 165
Futures (April) $ 165
Futures (April) Physicals
Jan Bought 141 Sold 141 (+ operating profit)
Mar Sold 165 Bought 165 (+ operating profit)
Profit +24 Loss -24
7/21/2019 Risk Workshop
24/28
Risk Manager
24
Creation of risk reports: P&L report , Risk Position Report,
Credit Risk report, Mark-to-Market report and VaR, Et cetera
Monitoring hedging of physical business
Communicate and agree upon exposure and limits with
trading team
Monitor trading limits using market data and forward curves
and report breaches to book owner and management
Reliable DataUnbiased
Data Platts Assessments
7/21/2019 Risk Workshop
25/28
Marking to Market
25
It allows an approximate P&L for the year to dateto be calculated
It assists in the day-to-day control of open positions
PROBLEMS Bid/offer spreads
Long-term positions
Embedded options Price and volume
Cash flow implications
7/21/2019 Risk Workshop
26/28
Instruments for Price Risk Management
26
Exchange
Futures
Over the Counter (OTC)
Forwards
Swaps Options
Several futures, swaps and options-based strategiescan be used by end-users to manage specific needs
Hedging periods and protection levels can be
customized to fit any maturity and price level
7/21/2019 Risk Workshop
27/28
Exposure
27
Where does the exposure to price risk lie???
Is there a credit risk?
How are market data used?
How forward curves are used to manage oil pricevolatility
What do you look at to lock contango and to eventuallyfix loss in a market that is in backwardation
7/21/2019 Risk Workshop
28/28
28
Hedging and Exposure
When is the right time to buy or sell a swap and lock the profit?
What triggers the decision to hedge the whole cargo?
Purchase
Physical
30,000
Futures
300 lots Sale
Physical
30,000Futures
300 lots
22-May 1,875 19 sell Jun 01-Jul 10,000 100buy Jul25-May 1,875 19 sell Jun 02-Jul 10,000 100buy Jul
26-May 1,875 19 sell Jun 03-Jul 10,000 100buy Jul
27-May 1,875 18 sell Jun
28-May 1,875 19 sell Jun
29-May 1,875 19 sell Jun
01-Jun 1,875 18 sell Jun
02-Jun 1,875 19 sell Jun
03-Jun 1,875 19 sell Jun
04-Jun 1,875 19 sell Jun
05-Jun 1,875 19 sell Jun
08-Jun 1,875 18 sell Jun
09-Jun 1,875 19 sell Jun
10-Jun 1,875 19 sell Jun
11-Jun 1,875 18 sell Jun
12-Jun 1,875 19 sell Jun
Top Related