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Collars provide energy producers and end users with price protection by
limiting extreme market moves. Collars are created by combining a price floor with a price cap, constraining price movement within a defined range. Costless collars are "paid for" by giving up a portion of a favorable price change. No cash premium is involved for costless collars.
For energy producers, collars offer floor protection on commodity sales prices. In exchange, the producer gives up some potential to benefit from favorable price moves by selling a cap. If prices move within the collar, or specified range of commodity prices, the producer will sell the commodity at prevailing market prices. However, if the price falls below the collar's lower limit, the producer can sell the commodity at the floor price. Correspondingly, if the market price for the commodity exceeds the collar's upper limit, the producer is obligated to sell at the cap price.
For energy end users, collars offer cap protection on commodity supply prices. In exchange, the end user gives up some potential to benefit from favorable price moves by selling a floor. If prices move within the specified range created by the collar, the end user will buy the commodity at prevailing market prices. However, if the price for the commodity exceeds the collar's upper limit, the end user can purchase the commodity at the cap price.
Correspondingly, if the market price for the commodity falls below the collar's lower limit, the end user must buy the commodity at the floor price.
In many ways, collars are similar to swaps, but they provide greater flexibility by allowing a specified degree of market exposure.
producer application
end user application
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