Derivatives Forwards
Commodity Forwards: with some focus on crude oil
6-1
Same concept applies…
• In general, commodity forward prices can be found using the same economic principles used for financial forward prices:
F0,T = S0 e
(r − δ )T
but the details will be different
6-2
Dirty details
• For financial assets, δ is the dividend yield • For commodities, δ is the commodity lease rate
The lease rate is the return that makes an investor willing to buy and lend a commodity
• Some commodities (metals) have an active leasing market • http://www.kitco.com/market/LFrate.html
• More typically, lease rates can only be estimated by observing forward prices
6-3
Think about a commodity loan
• If you loan a commodity, you are giving up S0 today, and will get back ST. • If loan is fairly priced, its NPV=0 • NPV = E0(ST)e-αT - S0,
• where α is required return on the commodity • if NPV=0, α is the “__________”
6-4
Commodity loan (cont)
• Now, suppose commodity price grows at rate g, E0(ST)= S0egT • Then, NPV = S0e(g-α)T - S0, • But now if g 0.5%
6-21
More oil characteristics
• Viscosity is a measure of how well if flows or the “friction” in the liquid
water is very low viscosity, mayonnaise would be high!
Pour point • The lowest temperature at which crude or other refined product flows as a liquid
Higher pour points can be more expensive to store and transport, because they may need heated
“Paraffinic” = low-viscosity and high flammability “Napthenic” = high-viscosity, but not highly flammable “Intermediate” = in between paraffinic and napthenic
6-22
Common oil types
• “Light and sweet”
API gravity between 33 and 45 degrees
• West Texas Intermediate (39.6) • Brent (North West European crude, 38.06) • Dubai (31) • Saudi Ghawar Field (33-40)
• “Heavy and sour”
API gravity between 10 and 33 degrees
• Urals (Eastern European crude)
APIs greater than 10 float on water
6-1
Same concept applies…
• In general, commodity forward prices can be found using the same economic principles used for financial forward prices:
F0,T = S0 e
(r − δ )T
but the details will be different
6-2
Dirty details
• For financial assets, δ is the dividend yield • For commodities, δ is the commodity lease rate
The lease rate is the return that makes an investor willing to buy and lend a commodity
• Some commodities (metals) have an active leasing market • http://www.kitco.com/market/LFrate.html
• More typically, lease rates can only be estimated by observing forward prices
6-3
Think about a commodity loan
• If you loan a commodity, you are giving up S0 today, and will get back ST. • If loan is fairly priced, its NPV=0 • NPV = E0(ST)e-αT - S0,
• where α is required return on the commodity • if NPV=0, α is the “__________”
6-4
Commodity loan (cont)
• Now, suppose commodity price grows at rate g, E0(ST)= S0egT • Then, NPV = S0e(g-α)T - S0, • But now if g 0.5%
6-21
More oil characteristics
• Viscosity is a measure of how well if flows or the “friction” in the liquid
water is very low viscosity, mayonnaise would be high!
Pour point • The lowest temperature at which crude or other refined product flows as a liquid
Higher pour points can be more expensive to store and transport, because they may need heated
“Paraffinic” = low-viscosity and high flammability “Napthenic” = high-viscosity, but not highly flammable “Intermediate” = in between paraffinic and napthenic
6-22
Common oil types
• “Light and sweet”
API gravity between 33 and 45 degrees
• West Texas Intermediate (39.6) • Brent (North West European crude, 38.06) • Dubai (31) • Saudi Ghawar Field (33-40)
• “Heavy and sour”
API gravity between 10 and 33 degrees
• Urals (Eastern European crude)
APIs greater than 10 float on water