Price Risk

Price risk is the most visible risk in commodity trading. Markets can move 5-10% in a day, and positions are often worth hundreds of millions of dollars. Managing this risk is essential to protecting margins.

Understanding Price Exposure

Types of Price Exposure

Type	Description	Example
Flat price	Outright level risk	Long 1M bbl unhedged
Basis	Physical-futures differential	Bonny Light vs Brent
Spread	Time spread (contango/backwardation)	M1 vs M6
Crack	Refining margin	Gasoline - Crude
Quality	Grade differential	Light vs heavy crude

Position Measurement

POSITION CALCULATION
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GROSS POSITION:
Total volume on each side (long/short)

NET POSITION:
Long - Short = Net exposure

EXAMPLE:
Physical long: 2,000,000 bbl
Futures short: 1,800,000 bbl
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Net exposure: +200,000 bbl (long)

DELTA EQUIVALENT:
Convert all positions to equivalent flat price exposure
Options → delta-adjusted volume
Spreads → leg-by-leg

Price Risk Measurement

Sensitivity Analysis

POSITION SENSITIVITY
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NET POSITION: +500,000 bbl crude

SENSITIVITY:
+$1/bbl move → +$500,000 P&L
-$1/bbl move → -$500,000 P&L

STRESS:
+$10/bbl → +$5,000,000
-$10/bbl → -$5,000,000

CONTEXT:
Expected daily move: ~$1.50/bbl (2% volatility)
Expected range: -$1.50 to +$1.50
Expected P&L range: -$750K to +$750K daily

Value at Risk (VaR)

VAR FOR COMMODITY POSITIONS
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PARAMETRIC VAR:
Position value: $37.5M (500K bbl × $75)
Daily volatility: 2%
Z-score (95%): 1.645
1-day VaR = $37.5M × 2% × 1.645 = $1.23M

INTERPRETATION:
95% confident daily loss ≤ $1.23M
5% chance of loss > $1.23M

10-DAY VAR:
$1.23M × √10 = $3.9M

MONTE CARLO VAR:
Simulate 10,000 price paths
Take 5th percentile outcome
More accurate for complex portfolios

Greeks for Options

Greek	Measures	Commodity Application
Delta	Price sensitivity	Position equivalent
Gamma	Delta change rate	Hedge rebalancing need
Vega	Volatility sensitivity	Vol exposure
Theta	Time decay	Option cost

OPTION GREEKS EXAMPLE
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POSITION: Long 500 call options @ $75 strike

Delta: 0.55 (55% of notional)
Gamma: 0.02 (delta changes 0.02 per $1)
Vega: $15,000 (per 1% vol change)
Theta: -$2,000/day

DELTA EQUIVALENT:
500 contracts × 1,000 bbl × 0.55 = 275,000 bbl

HEDGE REQUIREMENT:
Short 275 futures contracts to be delta-neutral

Price Risk Limits

Limit Structure

Limit Type	Purpose	Example
Position limit	Cap volume exposure	Max 5M bbl net
VaR limit	Cap statistical risk	Max $10M daily VaR
Stop loss	Cap cumulative loss	Close at $5M MTD loss
Concentration	Diversification	Max 30% in one product

Limit Monitoring

LIMIT MONITORING REPORT
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POSITION LIMITS:
               Current    Limit      %Used
Crude Net      3.2M bbl   5.0M bbl   64%
Products Net   0.8M bbl   2.0M bbl   40%
Metals Net     5K MT      10K MT     50%

VAR LIMITS:
               Current    Limit      %Used
Firm VaR       $5.2M      $10M       52%
Crude VaR      $3.8M      $6M        63%
Products VaR   $1.1M      $3M        37%

STOP LOSS:
               MTD P&L    Limit      Status
Crude desk     +$12M      -$5M       OK
Products       -$2M       -$3M       WATCH

BREACH PROTOCOL:
>80%: Alert desk head
>95%: Alert CRO
>100%: Mandatory reduction

Hedging Strategies

Basic Hedge

BASIC HEDGE STRUCTURE
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PHYSICAL EXPOSURE:
Buy 2M bbl crude FOB Nigeria
Price: Dated Brent + $1.50
Delivery: 45 days

HEDGE:
Sell 2,000 Brent futures contracts
Price: $75.50

OUTCOME:
Physical P&L = (Sale price - $76.50)
Futures P&L = ($75.50 - Close price)
Net = Locked spread ± basis movement

IF DATED BRENT FALLS TO $70:
Physical: Sell at $71.50 → Loss vs expected
Futures: Close at $70 → Gain of $5.50
Net: Margin protected

Basis Hedging

BASIS HEDGE
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PROBLEM:
Physical: Priced vs Dated Brent
Hedge: Brent futures
Basis: Dated Brent - Brent futures (EFP)

If EFP moves, hedge is imperfect.

SOLUTION:
Trade EFP (Exchange for Physical) swap
Locks in relationship between Dated and Futures

EXECUTION:
Physical: Long Dated Brent exposure
Hedge 1: Short Brent futures (flat price)
Hedge 2: Long EFP swap (locks basis)
Result: All price components hedged

Dynamic Hedging

DYNAMIC HEDGE MANAGEMENT
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INITIAL:
Physical: Long 2M bbl (Δ = 2M bbl)
Hedge: Short 2M bbl futures (Δ = -2M bbl)
Net Δ: 0

SCENARIO: Market rallies, consider upside participation

ADJUSTMENT:
Reduce futures hedge to 1.5M bbl
Net Δ: +0.5M bbl

OUTCOME:
If market rises $5: +$2.5M additional profit
If market falls $5: -$2.5M additional loss

USE CASES:
Strong view on direction
Hedge ratio optimization
Rolling hedge timing

Spread and Basis Risk

Calendar Spread Risk

CALENDAR SPREAD EXPOSURE
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POSITION:
Long M1 crude: 1M bbl
Short M6 crude: 1M bbl
Net flat price: 0
Calendar spread: Long 1M bbl (M1-M6)

RISK:
If spread narrows (M1 falls vs M6):
Spread change: -$2.00/bbl
P&L: -$2,000,000

HEDGE:
Trade calendar spread swap
Locks in current spread

MONITORING:
Track spread VaR separately
Spreads can move 10-20% in stressed markets

Location Basis Risk

LOCATION BASIS RISK
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EXPOSURE:
Physical: Bonny Light (priced vs Dated Brent + premium)
Hedge: ICE Brent futures

BASIS:
Expected: Bonny Light = Dated Brent + $1.50
Dated Brent = ICE Brent + $0.50 (EFP)
Total basis: $2.00

RISK:
If Nigerian premium collapses to $0.50:
Basis loss: $1.00/bbl
On 2M bbl: $2,000,000 loss

NOT HEDGED BY FUTURES ALONE

MITIGATION:
Trade Bonny Light swap (if liquid)
Diversify origins
Monitor Nigerian market closely

Risk Reporting

Daily P&L Attribution

P&L ATTRIBUTION
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DAILY P&L: +$1,250,000

BREAKDOWN:
Flat price movement: +$850,000
  Crude: +$650K (market up, long position)
  Products: +$200K

Spread changes: +$180,000
  Time spreads: +$120K (contango widened)
  Location basis: +$60K

Options: +$70,000
  Delta: +$50K
  Gamma: +$15K
  Vega: +$5K

New deal margins: +$150,000
  3 new trades booked

TOTAL: +$1,250,000

Scenario Analysis

SCENARIO ANALYSIS
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POSITION: Net long 500K bbl crude

SCENARIOS:
Scenario              Price Move    P&L Impact
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Base case             0%            $0
Moderate up           +5%           +$1.9M
Strong rally          +15%          +$5.6M
Moderate down         -5%           -$1.9M
Crash                 -20%          -$7.5M
2020 COVID replay     -50%          -$18.8M

CURRENT HEDGE: 90%
RESIDUAL EXPOSURE: 50K bbl
UNHEDGED RISK: 10% of scenarios

Key Takeaways

Position measurement is foundational — Know your exposure
VaR captures normal conditions — Stress tests reveal tail risk
Basis risk is often underestimated — Physical ≠ Futures
Limits must be actively monitored — Breaches addressed immediately
P&L attribution explains performance — Where did money come from?
Hedging reduces, doesn’t eliminate — Residual risks remain

References

Hull, John. “Options, Futures, and Other Derivatives”
CME Group Risk Management
GARP Market Risk Standards