 |
Swaps are privately negotiated financial contracts in which two parties agree to exchange, or "swap," specific price risk exposures over a predetermined period of time. They are "over-the-counter" instruments that can be customized to meet a particular set of needs.
Swaps allow for strategies designed to protect against market price fluctuations. When swaps are coupled with a physical position, energy producers can use them to lock in the specific price they will receive for the commodities they sell. Similarly, consumers of energy commodities can use swaps to lock in the specific price they will pay for the commodities they buy. By locking in prices, producers and consumers gain greater control over the variable revenues and costs inherent in their businesses.
There is no "cost" for a swap. When used in connection with floating price energy contracts, swaps afford a producer or end user protection from adverse price movements in exchange for giving up the ability to capitalize on beneficial price movements.
There are no standardized swap transactions. However, most transactions involve an exchange of periodic payments between two parties, with one side paying a fixed price and the other side paying a variable price. Specific terms of swap agreements - including the fixed price of a commodity and its floating price reference, the term of the contract and the quantity to be hedged - are established by the two parties involved, and can vary, subject to their specific needs and objectives.
A swap contract is settled in cash, usually against an agreed-upon market price index, and is customized as to volume, timing, location, seasonality and swing.
As reliable indices develop in the coal markets, swaps will provide coal producers and end users unprecedented ability to manage price risk.
producer application
end user application
|
