Risk Management in Commodity Markets: From Shipping to Agriculturals and Energy

2

Forward Curve Modelling in Commodity Markets

Svetlana Borovkova and Hélyette Geman

2.1 INTRODUCTION

Commodity markets have been buoyant for the last few years and commodity spot prices continue (at the time of writing) to reach new record highs, driven by a strong world demand and a tight supply, very sensitive to political or weather events. Moreover, for more than a century, forward markets have been the main place of commodity trading as they allow investors to avoid the hurdles of physical delivery while getting the desired exposure to changes in commodity prices. Most examples in this chapter dedicated to the fundamental problem of forward curve modelling will be investigated in the setting of strategic energy commodities such as crude oil or natural gas. But the methodology identically applies to other commodity classes, either seasonal such as agriculturals or non-seasonal such as metals.

First we recall some elementary definitions around forward and futures contracts. Forward contracts are traded over-the-counter between two parties and the grade of oil, delivery point, exact amount and exact delivery date are specified at the time of writing the contract. In this respect they are different from futures contracts, which are standardized in terms of the grade, amount, delivery date and location. Energy futures are traded on exchanges such as the InterContinental Exchange (ICE) and New York Mercantile Exchange (NYMEX). For instance, most of the trading activity in oil markets ...