ENERGY DERIVATIVES & RISK MANAGEMENT
based in Euros, the oil-linked gas cost in Euros could be hedged by taking the following actions over the life of the contract (see also Figure 1): 1. Hedge the Fuel Oil and Gasoil variable costs with a swap in USD
2. Hedge foreign exchange risk by selling USD and buying EUR
3. Unwind FX hedge ratably as contract starts pricing
4. Convert commodity swap settlements into EUR
5. Pay for gas based on actual invoice in EUR
Risk groups that need to quantify the
potential variability of gas costs and revenues in future time periods require a multi-step simulation framework with scenarios for multiple commodities and exchange rates that accounts for issues such as averaging periods, time lags and other dynamics specfic to these oil-linked gas supply contracts. In addition, there are often other non- price clauses such as destination optionality, take-or- pay provisions or revision clauses that can materially impact their value and risk.
Figure 1: Steps to Hedge an Oil-Linked Supply Gas Contract in Euros
Source: NQuantX
Managing and measuring the risk of oil-linked gas contracts requires an integrated approach to commodity and foreign exchange risks
While these are the basic steps for hedging oil-
indexed natural gas commitments, a combination of backtesting and forward-looking simulation of alternative strategies will support optimization of the
Footnotes:
1. For example, Statoil said in November 2013 that they were expecting to sell close to 50% of gas supplies priced off of gas market indices.
2. Druz and Blanco (2013)
3. We assume that the petroleum prices are originally quoted In USD and the swaps used for hedging commodity risks are also denominated in USD. A UK firm with revenues based on GBP would also have to hedge the GBP/EUR exposures since ultimately their profitability will be based on GBP revenues vs. GBP-translated costs.
4. Blanco and Druz (2013)
References: • Blanco, C. and Druz, T. (2013). Optimising commodity hedging programmes. Energy Risk. June 2013. • Blanco, C. Pierce, M. and Aragonés, J.R. (2012) IFRS 9, hedge effectiveness and optimal hedge ratios. Energy Risk. June 2013. • Druz, T. and Blanco. C. (2013) “An Integrated Approach to Commodity and FX Hedging” Commodities Now. December 2013.
key decisions comprising the hedging programme. These include the hedging horizons, proportions of exposures hedged, hedging proxies, financial instruments and timing for each of the commodities as well as the foreign exchange risk.
Summary Managing and measuring the risk of oil-linked
gas contracts requires an integrated approach to commodity and foreign exchange risks. In this article, we have shown the process to estimate gas costs for these contracts in different currencies, along with the steps required to manage the oil price as well as the currency risk. •
Carlos Blanco is Managing Director of NQuantX
LLC (
carlos@nquantx.com), a financial engineering firm that develops decision-support software for
energy and commodity trading and hedging, as well as valuation and risk measurement of derivatives, long term contracts and physical assets.
He is a faculty member of the Oxford Princeton
Programme, where he teaches the Energy Derivatives Pricing, Hedging and Risk Management Certificate (DPH), and other risk management, trading and behavioral finance courses.
www.oxfordprinceton.com
Tamir Druz is Director of Capra Energy Group (NQuantX’s alliance partner). Capra Energy
provides strategy advisory services for commodity and foreign exchange trading, forecasting and financial risk management.
www.nquantx.com March 2014 57
Page 1 |
Page 2 |
Page 3 |
Page 4 |
Page 5 |
Page 6 |
Page 7 |
Page 8 |
Page 9 |
Page 10 |
Page 11 |
Page 12 |
Page 13 |
Page 14 |
Page 15 |
Page 16 |
Page 17 |
Page 18 |
Page 19 |
Page 20 |
Page 21 |
Page 22 |
Page 23 |
Page 24 |
Page 25 |
Page 26 |
Page 27 |
Page 28 |
Page 29 |
Page 30 |
Page 31 |
Page 32 |
Page 33 |
Page 34 |
Page 35 |
Page 36 |
Page 37 |
Page 38 |
Page 39 |
Page 40 |
Page 41 |
Page 42 |
Page 43 |
Page 44 |
Page 45 |
Page 46 |
Page 47 |
Page 48 |
Page 49 |
Page 50 |
Page 51 |
Page 52 |
Page 53 |
Page 54 |
Page 55 |
Page 56 |
Page 57 |
Page 58 |
Page 59 |
Page 60 |
Page 61 |
Page 62 |
Page 63 |
Page 64 |
Page 65 |
Page 66 |
Page 67 |
Page 68 |
Page 69 |
Page 70 |
Page 71 |
Page 72 |
Page 73 |
Page 74 |
Page 75 |
Page 76