 |
AmmoniaKing, a producer of ammonia, anticipates a plant turnaround
starting in three months time and lasting for two months. The company
intends to build extra ammonia inventory of 50,000 tons over the next
three months to meet sales obligations during the two-month period the
plant is taken off-line. There is concern that prices could soften over the
two-month turnaround period, squeezing the margin on the excess
inventory to be sold during that time.
To protect against a sharp price reduction during the turnaround period,
AmmoniaKing buys a two-month ammonia price floor today that becomes
effective in three months time. The floor price is set at $145 and costs
$3/ton. The total premium payable by AmmoniaKing is $150,000 (50,000
tons multiplied by $3/ton).
During the life of the Price Floor
- AmmoniaKing sells excess ammonia inventory to its customers at
prevailing market (floating) prices.
- Enron receives a $3/ton premium from AmmoniaKing for the $145/ton
price floor.
- If the floating price for ammonia is greater than the $145/ton floor
price, there is no action under the floor contract. The effective price
received by AmmoniaKing for its ammonia is the floating market price
less the $3/ton premium.
- If the floating price goes below the $145/ton floor price to $140/ton, for
example, AmmoniaKing will receive the $5/ton difference from Enron. In
this instance, AmmoniaKing effective price for ammonia is $142/ton -
the $145/ton floor price less the $3/ton premium.
- In summary, the price floor has established a minimum price of
$145/ton with full upside potential at a known cost of $3/ton.
back to Caps and Floors
|
