Commodity derivatives : markets and applications

Description

Cover Title Page Copyright Contents Preface Chapter 1 Fundamentals of Commodities and Derivatives 1.1 Market overview 1.2 Market participants 1.2.1 Physical market participants 1.2.2 Price reporting agencies (PRAs) 1.2.3 Investment banks 1.2.4 Commodity trading houses 1.2.5 Hedge funds 1.2.6 ‘Real money’ accounts 1.3 Traded versus non‐traded commodities 1.4 Forward contracts 1.5 Futures 1.6 Swaps 1.7 Options 1.8 Exotic options 1.8.1 Binary options 1.8.2 Barrier options 1.8.3 Spread options 1.8.4 Average rate options Chapter 2 Derivative Valuation 2.1 Asset characteristics 2.2 Commodity prices and the economic cycle 2.3 Principles of commodity valuation 2.4 Forward price curves 2.4.1 Forward prices – a market in contango 2.4.2 Forward prices – a market in backwardation 2.4.3 Interpreting forward curves 2.4.4 Commodity arbitrage 2.5 Commodity swap valuation 2.5.1 Single and dual curve discounting 2.6 Principles of option valuation 2.6.1 Black Scholes and Merton 2.6.2 The Black model 2.6.3 Bachelier model 2.6.4 Put‐call parity: the theory 2.6.5 Put‐call parity: the application 2.7 Measures of option risk management 2.7.1 Delta 2.7.2 Gamma 2.7.3 Theta 2.7.4 Vega 2.7.5 Non‐constant volatility Chapter 3 Risk Management Principles 3.1 Defining risk 3.1.1 Subcategories of risk 3.2 Commodity market participants – the time dimension 3.2.1 Short‐dated maturities 3.2.2 Medium‐dated maturities 3.2.3 Longer‐dated exposures 3.3 Hedging corporate risk exposures 3.4 A framework for analysing corporate risk 3.4.1 Strategic considerations 3.4.2 Tactical considerations 3.5 Hedging customer exposures 3.5.1 Forward risk management 3.5.2 Swap risk management 3.5.3 Option risk management 3.5.4 Correlation risk management 3.5.5 Case study: Managing market and credit – the collapse of Japan Airlines 3.6 Trading risk management 3.6.1 Spot trading strategies 3.6.2 Forward trading strategies 3.6.3 Single period physically settled ‘swaps’ 3.6.4 Single or multi‐period financially settled swaps 3.6.5 Option based trades – trading volatility 3.6.6 Case study: Amaranth Advisors and the US natural gas market 3.6.7 Case study: Metallgesellschaft Chapter 4 Gold 4.1 The market for gold 4.1.1 Physical Supply Chain 4.1.2 Intermediaries 4.1.3 The London Gold Market 4.1.4 The LBMA gold price 4.2 Gold price drivers 4.2.1 The price of gold 4.2.2 Supply of gold 4.2.3 The Demand for gold 4.2.4 Gold price relationships 4.3 The gold leasing and deposit market 4.3.1 Forward price formation 4.3.2 Deriving implied lease rates 4.3.3 Who lends and borrows gold? 4.4 Hedging 4.4.1 Forwards 4.4.2 Swaps 4.4.3 Options 4.5 Trading gold 4.5.1 Gold swaps / FX swaps 4.5.2 Non‐deliverable gold swaps 4.5.3 Deferred margin accounts 4.6 Yield enhancement 4.7 Summary Chapter 5 Base Metals 5.1 Overview of base metal production 5.2 The copper lifecycle 5.2.1 Copper resources 5.2.2 Uses of copper 5.2.3 The copper supply chain 5.2.4 The role of scrap copper 5.2.5 Trading copper 5.3 Aluminium 5.4 The Steel market 5.4.1 Factors impacting the price of steel 5.4.2 Steel risk management 5.5 The London Metal Exchange 5.5.1 Exchange traded metal futures 5.5.2 Exchange traded metal options 5.5.3 LME prices and contract specification 5.5.4 Trading 5.5.5 Clearing and settlement 5.5.6 Delivery 5.6 Base metal price drivers 5.7 Electric Vehicles 5.7.1 Lithium 5.7.2 Cobalt 5.8 Structure of market prices 5.8.1 Long‐term prices 5.8.2 How do forward curves move? 5.8.3 Are forward prices forecasts? 5.8.4 The role of marginal costs 5.8.5 Premiums 5.9 Hedges for aluminium consumers in the automotive sector 5.9.1 Forward purchase 5.9.2 Carry trades in the base metal market 5.9.3 Vanilla option strategies 5.9.4 Short option positions 5.9.5 Combination option strategies 5.9.6 Structured option solutions 5.9.7 Foreign currency exposures 5.10 Summary Chapter 6 Crude Oil 6.1 Overview of energy markets 6.2 The value of crude oil 6.2.1 Basic chemistry of oil 6.2.2 Density 6.2.3 Sulfur content 6.2.4 Acidity 6.2.5 Flow properties 6.2.6 Other chemical properties 6.2.7 Examples of crude oil 6.3 An overview of the physical supply chain 6.4 Refining crude oil 6.4.1 What is refining? 6.4.2 What does a refinery produce? 6.4.3 Product yields 6.4.4 How does a refinery work? 6.4.5 Refinery optimisation 6.4.6 Refinery yields and relative crude oil prices 6.4.7 Measuring profitability 6.4.8 Drivers of refinery performance and profitability 6.5 The demand for and supply of crude oil 6.5.1 Proved oil reserves 6.5.2 R/P Ratio 6.5.3 Production of crude oil 6.5.4 Consumption of crude oil 6.5.5 Crude oil trade 6.5.6 Demand for refined products 6.5.7 Security of supply (and demand) 6.6 Price drivers 6.6.1 Macroeconomic issues 6.6.2 Supply chain considerations 6.6.3 Geopolitics 6.6.4 Analysing the forward curve 6.7 The price of crude oil 6.7.1 Defining price 6.7.2 The evolution of crude oil prices 6.7.3 Delivered price 6.7.4 Marker crudes 6.7.5 Pricing sources 6.7.6 Pricing methods 6.7.7 Pricing a cargo of crude oil 6.8 Trading crude oil and refined products 6.8.1 Overview 6.8.2 The Brent complex 6.8.3 US crude oil markets Notes 6.9 Managing price risk along the supply chain 6.9.1 Producer Hedges 6.9.2 Refiner hedges 6.9.3 Refined product hedges Chapter 7 Natural Gas 7.1 Formation of natural gas 7.2 Measuring natural gas 7.3 The physical supply chain 7.3.1 Production 7.3.2 Shippers 7.3.3 Transmission 7.3.4 Interconnectors 7.3.5 Storage 7.3.6 Supply 7.3.7 Customers 7.3.8 Non‐physical participants (NPPs) 7.4 Deregulation and re‐regulation 7.4.1 The US experience 7.4.2 The UK experience 7.4.3 Continental European deregulation 7.5 The demand for and supply of natural gas 7.5.1 Relative importance of natural gas 7.5.2 Reserves of natural gas 7.5.3 Production of natural gas 7.5.4 Shale gas 7.5.5 Reserve to production ratio 7.5.6 Consumption of natural gas 7.5.7 Exporting natural gas 7.5.8 Liquefied natural gas (LNG) 7.6 Natural gas prices 7.6.1 Natural gas price definitions 7.6.2 Oil indexation in the natural gas market 7.6.3 Liquefied natural gas (LNG) prices 7.7 Natural gas price drivers 7.7.1 Supply side price drivers 7.7.2 Demand side price drivers 7.7.3 LNG price drivers 7.8 Trading natural gas 7.8.1 Motivations for trading natural gas 7.8.2 Contract types 7.8.3 Delivery points 7.8.4 Trading natural gas in the UK 7.8.5 On‐the‐Day Commodity Market (OCM) 7.9 Natural gas derivatives 7.9.1 Exchange traded futures contracts 7.9.2 Over‐the‐counter natural gas transactions CHAPTER 8 Electricity 8.1 What is electricity? 8.1.1 Conversion of energy sources to electricity 8.1.2 Primary sources of energy 8.1.3 Commercial production of electricity 8.1.4 Measuring electricity 8.2 The physical supply chain 8.3 Market structure and regulation 8.3.1 The European Experience 8.3.2 Overview of UK regulation 8.3.3 The American Experience 8.3.4 Wholesale markets in the USA 8.4 Price drivers of electricity 8.4.1 Demand for electricity 8.4.2 Supply of electricity 8.4.3 Factors influencing spot and forward prices 8.4.4 Negative prices 8.4.5 Spark and dark spreads 8.4.6 Marginal heat rates 8.5 Trading electricity – an overview 8.5.1 Load shapes 8.5.2 Contract volumes 8.5.3 Contract prices and valuations 8.5.4 Price formation 8.5.5 Optimising production 8.5.6 System imbalances 8.5.7 Timing mismatches 8.5.8 UK trading conventions 8.5.9 US traded markets – an overview 8.6 Electricity derivatives 8.6.1 Electricity forwards 8.6.2 Electricity swaps 8.6.3 Contracts for difference 8.6.4 Swaptions 8.6.5 Spread options 8.6.6 Monetising embedded optionality 8.6.7 Ratio swap on power and aluminium 8.6.8 Monthly and daily power swaps 8.6.9 Options on power swaps 8.6.10 Heat rate derivatives CHAPTER 9 Plastics 9.1 The chemistry of plastic 9.2 The production of plastic 9.3 Monomer production 9.3.1 Crude Oil 9.3.2 Natural Gas 9.4 Polymerisation 9.5 Applications of plastics 9.6 Summary of the plastics supply chain 9.7 Price determination 9.8 Plastic price drivers 9.9 Forwards and swaps Price fixing hedge Offset hedge Proxy hedges 9.10 Option strategies CHAPTER 10 Bulk Commodities 10.1 The basics of coal 10.2 The demand for and supply of coal 10.3 Coal – the physical supply chain 10.3.1 Production 10.3.2 Main participants 10.3.3 Factors affecting the price of coal 10.4 Coal derivatives 10.4.1 Exchange traded futures 10.4.2 Over the counter solutions 10.5 Iron ore 10.5.1 Background 10.5.2 Evolution of iron prices 10.5.3 Iron ore derivatives 10.6 Freight markets – the fundamentals 10.6.1 Vessel types 10.6.2 Freight charges 10.6.3 Freight market participants 10.6.4 An overview of dry freight indices 10.6.5 Worldscale 10.6.6 Freight price drivers 10.6.7 Freight Derivatives CHAPTER 11 Climate and Weather 11.1 The science of climate change 11.1.1 Definitions 11.1.2 Greenhouse Gases 11.1.3 The carbon cycle 11.1.4 Feedback loops 11.2 The consequences of climate change 11.2.1 Fifth assessment report of the IPCC 11.3 The argument against climate change 11.4 History of human action against climate change 11.4.1 Formation of the IPCC 11.4.2 The Earth Summit 11.4.3 The Kyoto Protocol 11.4.4 From Kyoto to Paris 11.5 Price drivers of emissions markets 11.6 EU Emission Trading System 11.6.1 Background 11.6.2 System design 11.6.3 Cap and trade versus carbon taxes 11.7 Emission derivatives 11.7.1 Introduction 11.7.2 Spot transactions 11.7.3 Forwards – fair value pricing 11.7.4 Repurchase agreements 11.7.5 Swaps 11.7.6 Physical and cash‐settled options Notes: 11.7.7 ‘View driven’ strategies 11.8 Weather derivatives 11.8.1 Potential industries 11.8.2 General characteristics 11.8.3 Exchange traded futures 11.8.4 Over‐the‐counter structures 11.8.5 Swaps 11.8.6 Options 11.8.7 Applications – cattle industry 11.8.8 Applications – power utilities CHAPTER 12 Agriculture 12.1 Agricultural markets 12.2 Definitions 12.3 Agricultural products 12.3.1 Physical supply chain – wheat 12.3.2 Wheat 12.3.3 Corn 12.3.4 Palm oil 12.3.5 Soybeans 12.4 Soft commodities 12.4.1 Sugar 12.4.2 Coffee 12.4.3 Cocoa 12.5 Ethanol 12.5.1 What is ethanol? 12.5.2 History of ethanol 12.5.3 Supply chain: corn to ethanol 12.6 Price drivers 12.6.1 Physical market factors 12.6.2 Societal factors 12.6.3 Governmental intervention 12.6.4 Financial factors 12.7 Exchange traded agricultural and ethanol derivatives 12.8 Over‐the‐counter agricultural derivatives Swaps Vanilla swaps – exotic requirements Options Options on spreads Target Redemption Structures (TARNs) CHAPTER 13 Commodity‐Linked Financing 13.1 The financing need 13.1.1 Loan structures 13.1.2 Definitions 13.1.3 Financing case studies 13.2 Project finance 13.3 Working capital and the asset conversion cycle 13.3.1 Monetising inventories using repurchase agreements 13.3.2 Tri‐party agreements/margin financing 13.3.3 Prepay structures 13.3.4 Prepaid variable forwards 13.3.5 Lending risks 13.3.6 The commodity carry trade 13.3.7 Supply and offtake agreements 13.4 Longer‐term debt funding solutions 13.4.1 Embedding vanilla optionality into a loan 13.4.2 Commodity‐linked interest rate hybrids CHAPTER 14 Commodity Investing 14.1 Commodity investors 14.2 Preferred instruments 14.3 Market size 14.4 Rationale for investing in commodities 14.4.1 Return enhancement and diversification 14.4.2 Inflation hedge 14.4.3 Hedge against US dollar 14.5 Commodity indices 14.5.1 Construction 14.5.2 Quoting conventions 14.5.3 Evolution of index construction 14.5.4 The myth of the roll yield 14.6 Total Return Swaps 14.7 Exchange traded products (ETPs) 14.7.1 Exchange traded commodities 14.7.2 Exchange traded fund 14.7.3 Exchange traded note (ETN) 14.8 Structured products 14.8.1 Capital protected notes 14.8.2 Structuring considerations 14.8.3 Basket notes 14.8.4 Income structures 14.8.5 Reverse convertible 14.8.6 Autocallable structures 14.8.7 Outperformance note 14.8.8 ‘Worst of’ structures Glossary Bibliography Biography Index EULA