A Cap is a paper hedge agreement designed to protect you from rising prices, yet allows you to benefit from falling prices. Also known as “call option”. 

Here’s an example of how it works. To begin, you and Global agree upon:

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THE MONTHLY VOLUME

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AN OFFICIAL ENERGY PRICE INDEX (PLATTS/ARGUS)

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A HEDGING PERIOD (E.G. 2 MONTHS)

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A CAP PRICE (E.G. 110 PER TONNE)

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AN UPFRONT PAYABLE INSURANCE PREMIUM

graph showing your cap price

Month 1

Monthly average settles at 95 per metric tonne (15 below the cap level). There is no settlement of the Cap, so you will take advantage of the lower spot prices.

Month 2

Monthly average settles at 125 per metric tonne (15 above the cap level). Global pays you 15 per metric tonne in cash, compensating you for the increase in spot prices. 

Result

 

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Protection against increasing prices, yet benefit from falling prices

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Maximum payment from you to Global is the insurance premium

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At the end of each calendar month, the settlement amount is based on the difference between the monthly average of the price index - and the Cap price

Two good reasons to use this strategy:

 

  • Rising fuel prices would seriously undermine you business
  • You would like to benefit from falling prices after having fixed your maximum fuel prices

    BENEFITS

    Protection from price increases, benefit from falling fuel prices & flexibility in physical supply

    DISADVANTAGES

    Premium upfront & potentially some basis risk

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    Zero Cost Collar

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    Other Tools

    Swaps

    graph showing your swap price

    Capped Swaps

    graph showing your reduced swap price

    Zero Cost Collar

    graph showing zero cost dollar