Upload
august-simon
View
218
Download
2
Tags:
Embed Size (px)
Citation preview
Price Risk ManagementDr Abdelatif AbadaBP - Structured Products
Algeria 2006Algeria 2006
Africa Oil & Gas Trade & Africa Oil & Gas Trade & Finance Finance
Algiers - April 2006Algiers - April 2006
NOT AN OFFICIAL UNCTAD RECORD
DisclaimerThis presentation and any services described in it are intended only for Market Counterparties or Intermediate Customers as those terms are defined by the UK Financial Services & Markets Act 2000 and the FSA Handbook, or only for Eligible Contract Participants as that term is defined in the U.S. Commodity Exchange Act.This presentation and its contents have been provided to you for informational purposes only. This information is not advice on or a recommendation of any of the matters described herein, whether they consist of financing structures (including, but not limited to senior debt, subordinated debt and equity, production payments and producer loans), investments, financial instruments, hedging strategies or any combination of such matters and no information contained herein constitutes an offer or solicitation by or on behalf of BP p.l.c. or any of its subsidiaries (collectively "BP") to enter into any contractual arrangement relating to such matters. BP makes no representations or warranties, express or implied, regarding the accuracy, adequacy, reasonableness or completeness of the information, assumptions or analysis contained herein or in any supplemental materials, and BP accepts no liability in connection therewith. The actual terms and conditions of any contract or specific arrangement that may be entered into between you and BP may differ from the arrangements described in this presentation. BP deals and trades in energy related products and may have positions consistent with or different from those discussed herein. There is no assurance that the structure described herein will hedge risks the recipient may incur in the operation of its business. Prior to dealing in any investment or financial instrument or entering into any risk management product arrangement, you should obtain your own tax, legal and other advice as they may expose you to inappropriate financial risk.
Content
• Context & Back to Basics• What is Price Risk
Management• Various type of Solutions
– Tools and derivative instruments– Structures & hedging strategies
• Summary
Context: Energy Risk
• World events and growth have thrown a spotlight on security of energy supply, energy costs and price volatility
• Energy costs & revenues are a significant source of uncertainty for budgeting purposes
• They feed directly through to a company’s bottom line
• The need to understand energy market risk has never been greater
Who are the players? Types of energy traders• Producers
– Oil and gas producers– Renewable power generators
• Transformers– Power generators– Oil refiners– Chemical refiners– Resellers
• End Users– Air, land and sea transport companies– Commercial and industrial users– Domestic users– Governments
Types of trading1. Speculation: taking risky positionsrisky positions in a market with the intention of
exploiting market price movements.– Frequent In & out of the Market looking for potential gain opportunities – View driven– Take a bet on the future direction of a market– Want price volatility (uncertainty) to increase– Will enter into deals and set limits when to exit
2. Hedging: trading activity intended to reduce the riskinessreduce the riskiness of a portfolio.– Reduce/eliminate the risk faced from potential future price movements– In & out of the Market only when there is a (strategic) business– Business objective driven– Reduce/”hate” exposure to volatility of the business– Want certainty at the cost of sacrificing away potential upside – No surprise approach
3. Arbitrage: trading activity resulting in a riskless profitriskless profit, usually arising from participants exploiting inefficiencies in a market or mis-pricing of derivatives. The forces of supply and demand usually ensure these price mismatches subsequently disappear as a result of the trade being executed.
Some Definitions: What is risk?
• Most dictionary definitions of risk relate to hazard, exposure to misfortune, or other quite negative meanings
• Definition for our purposes:
Risk:Exposure to an uncertainty
• Risk Management or Hedging: is about transforming an “unknown” (uncertain) future cash flow to a “known” (certain) one
Risk management objectives
Use of Price Risk Managment Tools to meet the following objectives:
• Costs and revenues stabilisation • Secure positive margins• Elimination of price risk to ensure budget
predictability• Competitive advantage• Strategic hedged-based finance
Types of marketsExchange
FuturesStandardised options
• Volumes are regulated• Indices are restricted
(Brent, WTI, etc)• Delivery and settlement
dates are regulated• “Clearing houses”• IPE, NYMEX, ICE, CBOT,
SFE…
Over The CounterSwapsExotic optionsPackages and structured Products
• No restriction on volumes• All indices/products are
traded• Delivery/Settlement
dates are agreed upon• Hedging structures are
designed to meet exact exposure
Types of risk management tools• Linear instruments
– Fixes the future price at a level agreed today (forwards, futures, swaps)
• Non-linear instruments– Right of achieving a maximum or a minimum
protection price (options and derivatives)
• Structured products– Tailored package (combination of above) – Interaction between different risk factors (physical
commodities, FX, interest rates, freight, etc)
Swap contracts• A purely financial (paper) transaction between two
parties who agree to make regular payments to each other in the future
• Allows the exchange of a variable or floating price for a schedule of fixed price payments
• Swaps can pay out on the basis of differing notional volumes month-by-month
• Need to agree:– Floating price index – volume– time period– fixed price
• No premium outlay
Swap: Application
Refinery Seller
Fuel Oil
V (tons)Customer
0.7
*V (
ton
s)
FOn($)
bpriskmanager
V (tons)
Fixed($)
Fuel Oil
FO
n($
)
P0(
$)
• Decision made to:
• fix the price of Fuel Oil;
• for the next 1 year;
• in US$ or other (e.g., €)
• Buy a Swap on FO:
• Monthly cash settled;
• pay a fixed price P0($);
• receive the floating price FOn($)
• for the next 12 months;
•Volumes (tons) per month = 0.7*V
Net Margin for Seller on a given month: 30% × (Fixed – FOn) + 70% (Fixed – P0)
Option instruments• Options are derivative instruments that provide the holder with
the right, but not the obligation, to pay or receive some quantity of cash or commodity, at an agreed strike price
• Options come in many different flavours, and have a whole language associated with them
• A call option provides the holder with the right, but not the obligation, to receive the underlying at some agreed strike price, an operation known as exercising
• A put option provides the holder with the right, but not the obligation, to exercise by selling the underlying at the strike price
• Options are asymmetric, they guarantee their holder needs never exercise unless market prices are in their favour
• Since there is no such thing as a free lunch, the option purchaser needs to pay an option premium for this “insurance”
Option: Application
bBrentabtuP nn )/($
Buyer Supplier
Gas
V (tons) bpriskmanagerV×a (bbls)
Brentn($)
K= $40
• Decision made to:
• protect against prices ≤ $40/bbl;
• for the next 10 years;
• on 100% of the volumes
• Buy a Put Option on Brent:
• Monthly cash settled;
• pay a premium p upfront, or
• as part of settlement;
• receive: Max (0, $40 – Brentn) per bbl;
• for the next 10 years;
•Volumes (bbls) per month = a×V
Net price to receive for LNG for next 10 years: Pn($) = [a × Max(40, Brentn) + b] - p
$$-premium
Option: Applicationa = 0.1; b = 0premium= $5/bbl
LNG Price Formula ($/Ton)
0
1
2
3
4
5
6
7
8
9
10
0 10 20 30 40 50 60 70 80 90 100
Brent ($/bbl)
Ne
t L
NG
pri
ce
@ d
eli
ve
ry
Do Nothing Put Protection
Option prices• Option premiums are impacted by:
– Current market price (Forward prices)– Strike price– Time to expiry– Risk-free interest rates– Volatility of the underlying market
• Volatility is the most important “unobservable” market data.– It is a measure of the uncertainty/instability of
future prices
Hedging Refinery Crack Margin
• Consider a refinery of 55kbd• Consider that the refiner needs to meet
some fixed payments during next 2 years to service a $120MM loan. I.e. $5MM per month*
• Consider the Jet Fuel yield is 30% (i.e. 16.5kbd)
• Market Forward price for Crude and Jet Fuel are such as the margin for next two years is: $10/bbl
*Ignore interest effect
Hedging Crack Spread: Example
Solution to secure repayments:• Refiner Sells a Swap • Underlying: Refining margin Jet/Crude• Volume: 16.5kbd (i.e. ~500kbbls/month) • Period: 2 Years • Starts: July-06• Ends: June-08• Settlement: end of each Calendar month• Fixed price: $10/bbl
*Ignore interest effect
Hedge and Physical Transactions
bpriskmanager
Refinery
Fixed = $10/bbl Floating: Monthly average of Margin
Settlement Amount = Monthly Volume * ($10 – Margin)Settlement Amount = Monthly Volume * ($10 – Margin)
Settled by either party on, say, 5 business days after end of Settled by either party on, say, 5 business days after end of each month each month
Physical market
Floating: Monthly average of Margin
Physical crude and product
Hedging Crack Spread: ExampleWhat happens at each settlement?
Physical Transaction
Crack Spread Swap outcome to Refinery: $10.0 - Margin
Net Effect: Achieved Margin = $10.0
Secure Payment of $5MM / month
Crud
e Pr
ice
($/b
bl)
Jet price ($/bbl)
Another Mitigation Solution:Indexation
• Refinery can buy Crude on a price linked, e.g., to gasoil price:– Crude Oil price ($/bbl) = a* Gas Oil price + b
– a & b two constant parameters
• Or,• Refinery enter into a “reference swap” (i.e.
financial hedge) where Crude oil price is swapped to a Gas Oil price (formula as above)
Summary • An ENERGY player can add value to its
business through:– Understanding the Risk Management solutions
that exist to manage price exposure;– Being able to enter into the most appropriate
solution when needed, after defining the business model of the company (how much exposure to hedge? How far in time? And other corporate considerations); and
– Transact when a decision is made to hedge.• Once it executes the appropriate hedge, one
becomes indifferent to prices movements during the hedged period.
Something to remember...
• Price Risk Management is not Speculation
• It is about reducing risk to future market movement
• It is about Margin & Return On Investment stabilisation/Protection
• It is about seeking certainty in an uncertain world
bpriskmanager Services bpriskmanager is a core part of BP’s Integrated
Supply and Trading Organisation We offer cross-commodity and cross-currency hedging
service to BP and to external counterparties Our activities comprise derivatives marketing,
commodity options trading, financial FX, Money Market & Metals trading, and structured products
bpriskmanager works with its partners to help them understand their risk exposures, and explains the range of hedging tools available to them, including in-house financially-engineered structures. It then prices and transacts the hedge selected by the customer
BP’s Customers
Marketing (bpriskmanager):London, Chicago and Singapore
Products•Gasoil•Jet•Gasoline•Naphtha•Fuel Oil
Crude Oil Gas & Power & Emissions
Shipping Freight
Metals •Non/precious
Forex & MoneyMarkets
StructuredProducts
Options
Quantitative Analysis
OilMarket
Analysis
StructuredFinancing
OTC
BP’s Trading Books
Context within BP Trading