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