risk workshop

7/21/2019 Risk Workshop

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2013 Pl atts, McGraw Hill Financial. All rights reserved.

Risk Management Workshop:The Middle Distillate Case

Mr Antonio JulianoManager Risk Data Services-EMEA

[email protected]

September 03, 2013
mailto:[email protected]:[email protected]


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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


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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


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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


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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


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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


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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.


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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)


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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


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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


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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:


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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



01-Jun 1,875 18 sell Jun


03-Jun 1,875 19 sell Jun04-Jun 1,875 19 sell Jun








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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$


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15


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


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16


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


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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



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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



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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


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Appendix

Risk Management Workshop: The Middle Distillate Case


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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


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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


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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


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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


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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


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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


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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


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28


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














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