Home / Summaries / Class notes - Part 3: Financial Market and Products / price-commodity-stored

Commodity Forwards and Futures

5 important questions on Commodity Forwards and Futures

What is a commodity?

A commodity is characterized by its physical properties, the date at which it will be available, and the location at which it will be available. Important is the difference with financial assets and that is what we will find out in this reading.

What is the equilibrium price for commodity forwards?

The time-T forward price discounted at the risk-free rate is the present value of a unit of commodity received at time T. The PV of future oil cost can be calculated by discounting oil forward prices at the risk-free rate.

How about storage costs?

Not always feasible (perishable) or very costly. The forward price must be high enough to compensate for both the financing and the storage costs. When storage costs occurs the forward curve can rise faster than the interest rate (see it as a negative dividend yield). The fact that it can be stored doesn't mean that it should or will be stored as new supply can come in as well.

A forward price that is too high can give rise to arbitrage (due to storage), but a forward price that is too low may not need so (lease rate).

What about energy markets?

Electricity, cannot be stored with fixed supply and diverse demand (day, year, region, etc). There is price discovery!! The future price tells something about supply and demand.

Natural gas, more seasonality but can be stored. Once production is started it is hard to shut it down. Transport regionally is expensive. Contago market before demand increases. In tropical ares demand is more stable.

Oil, easier to transport but different quality, usually relatively flat.

What about commodity spreads?

Oil is used to make gasoline, kerosene and heating oil. Splitting in different components is called cracking. Difference is price between crude oil and equivalent amounts of subs is called the crack spread.

The question on the page originate from the summary of the following study material:

Part 3: Financial Market and Products

View summary