Technical University Munich Commodities as an Asset Class - risklab

2.3 Trading Commodities
2.3.1.3 Swaps
Commodity swaps are generally the same like interest rate swaps 49 with the difference
that the underlying payment streams are linked to the price movement of
a commodity. A swap is an agreement between two parties to regularly exchange
payments. The most common type is the fixed-for-floating commodity swap. The
buyer of the swap pays at predefined usually equally spaced dates t 1 , . . . , t n a fixed
price for a commodity times the notional and receives from the seller of the swap
the market value of the commodity times the notional. Hereby the notional is given
in commodity units, e.g. tones of grain or barrels of oil. Figure 2.17 illustrates the
exchange of payments at the oil market.
Figure 2.17: Commodity Swap Payment Streams
In order to hedge his cost structure a crude oil consumer such as an heating oil
refiner enters into the described swap as the fixed leg, e.g. he is going to pay a fixed
price for crude oil times the notional at predefined dates. Generally, he will expect
oil prices to rise. On the other hand of the swap stands the producer of oil, e.g. the
oil extraction company. It can be expected that its financial management forecasts a
price decrease and wants to sell its product to a price fixed on the current high level.
In vocabularies of cash settlement e.g. he is going to pay the floating (respective
market) price times the notional. Usually, just the net positions are cash settled.
Generally, as described under Section 2.2, producer and consumer do not act directly
with each other but traders manage to bring the adequate parties together. We
have seen that the side of the swap entered by a party depends on its expectation of
ongoing price developments. Because many commodity swaps are cash settled today,
investors can speculate on their expectation through entering into the respective side
of a swap instead of entering into a series of the respective futures contracts. Out of
the investors point of view an advantage of swaps is the long term orientation and
the absence of rolling maturing futures contracts.
Swaps can easily be used in structured products where the exchange of different
49 For a general introduction to interest rate swaps see [Zagst 2002]
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