Local investors hedge against global crude oil volatility

Oil price volatility and its current price of just short of $110 a barrel, the Johannesburg Stock Exchange (JSE) has seen increased trade in crude oil commodity derivative contracts from local investors hedging their fuel exposure.

Since late 2009, the JSE has offered exposure to the world’s most liquid crude oil market through a licensing agreement with the CME Group, by providing exposure to light sweet crude oil, also known as West Texas Intermediate (WTI). While Brent is commonly assumed to be the global benchmark for crude oil, WTI is substantially more liquid. Companies with large exposure to the price of diesel, for example, can use both oil options and futures contracts to better manage their fuel exposure. Participants are able to achieve international exposure in Rands through a local JSE authorised derivatives member firm.

To date over 8,300 contracts have traded, each representing 100 barrels of crude oil. Open interest, which reflects the number of open positions held by buyers and sellers, is about 8,8million litres. The JSE’s General Manager for Commodity Derivatives, Chris Sturgess comments: “Certain businesses are exposed to the price volatility of the crude oil market. These companies could turn to the market to manage their price risk. While speculative trading opportunities exist, this market may provide an opportunity for participants to hedge their crude oil exposure.”

One logistics company that wished to hedge itself against rising diesel prices bought call options at the capped price or strike price of R740 and R750 per barrel for the August close-out, says Gerhard Labuschagne, the trader from BFI who secured the contracts on the company’s behalf. “In essence the company is assured that should the price of crude oil go up in Rand terms, their maximum price is capped at R740 per barrel. This right comes with no obligations and the logistic company paid R61 per barrel in option premium. Should the price of crude oil trade much lower, the company benefits from the lower prices. If oil prices continue to rise, they have protected their upside for a total cost of R61 per barrel,” says Labuschagne.

Labuschagne says a company can hedge itself against rising diesel prices by buying a call option (which gives the company the right to buy oil in the future at a price fixed today). “There is a high correlation between oil and diesel prices. If oil prices go up you can assume diesel will go up too. If that happens, the value of the call option goes up in value. You can then sell the call option at the higher price later on. If oil prices rise above the strike price of your option, the company gets the difference between strike and the higher oil price.”

The main driver for listing derivatives on the foreign referenced commodities like crude oil, copper and silver on the JSE was to provide easy access for local market participants to the international markets without the need to seek Reserve Bank approval, says Sturgess. “These products came with instant liquidity as market makers, namely ABSA Capital, Standard Bank and Nedbank Capital, quoted competitive doubles based off the international reference CME market.”

Contract specs

The design of the JSE contract was done to enable easier access for the retail clients or smaller hedgers, and so a standardised contract represents the following:

• 1 contract is equivalent to 100 barrels of WTI crude oil
• 100 barrels is just under 15 900 litres
• The contract is quoted in Rand per barrel, so for a June 2011 expiry the currently traded price is around R735.00 per barrel. The Rand price is derived from quoted prices in the US market taking into account the Rand Dollar exchange rate applicable to the expiry day
• To focus trading, the following 4 expiry months are available: February, June, August and December
• JSE trading cost is R10/contract or 10 cents per barrel for futures and R6/contract for options
• Put and Call options available are options on the futures contract