Commodity Swap
Also known as: Fixed-for-floating commodity swap
Fix the price of a flow: months or years of oil, gas or metal, settled in cash against published indices.
1 · SnapshotThe one idea to remember
2 · BeginnerWhat is it, really?
A commodity swap fixes the price of a continuing stream of a commodity: one side pays a fixed price per unit, the other pays the floating market price (a published index average), settled in cash each period. No barrels move — the physical purchases continue as normal, and the swap's cash flows offset their price swings.
It's the natural hedge for flows rather than moments: an airline burns fuel every day of the year, a utility buys gas every month. A strip of futures could approximate this, but a swap does it in one contract, tailored to exact volumes, months and indices (jet fuel Rotterdam, not just crude).
The result: a CFO can budget fuel or metal costs years ahead with one signature.
a paymentnot a payment
An airline that needs fuel does not want fuel delivered to a clearing house. It wants the price fixed, and this is how.
Every month, on the swap
- The consumer → The bank Agreed for a stated volume, months or years ahead. This is the number the company can put in its budget.
- The bank → The consumer Averaged over the month. Only the difference between the two is actually paid.
netted: only the difference is paid
Every month, in the real world
- The consumer → Its actual supplier Bought from an ordinary supplier at whatever it costs on the day. The swap does not deliver anything.
What is left over
- The consumer → The bank The index in the swap and the price at the company's own airport are not the same number. The gap between them is what a hedge cannot remove, and it is the risk that survives.
- Asset class
- Commodities
- Instrument type
- Swap (cash-settled)
- Traded
- OTC + cleared lookalikes
- Typical users
- Airlines, utilities, miners, trading houses
Which risks decide the outcome
Not how risky this is, and not a rating — there is deliberately no total. It says which of five failure modes drives what happens here, in the same order on all 129 products so they can be compared. This publication's own reading; see the notice below.
- Marketdecides it
- Creditmatters
- Liquiditybarely applies
- Fundingmatters
- Operationalbarely applies
What decides it here. The index in the swap and the price at your own location are not the same number. That gap is what a hedge cannot remove.
3 · IntermediateHow it works in practice
Structure
- Periods: monthly settlements over 1–5 years, each against the month's average index price.
- Indices: Platts/Argus assessments, exchange settlements — the reference's quality defines the hedge's honesty.
- Basis swaps: float-for-float between two indices (WTI vs Brent, hub vs hub) — hedging the difference, which for physical players is often the bigger risk.
Why swaps over futures
- Averaging matches reality: consumption is spread over the month, and swaps settle on the average.
- Tenor and tailoring: illiquid far months, odd products (jet fuel, LNG-linked), volume profiles.
- Credit terms: banks lend hedging capacity via CSAs or credit lines — no daily margin cash calls (a lifeline in 2022, when margin on gas futures nearly broke European utilities; also a hidden leverage risk).
The 2022 lesson
Energy hedgers with exchange-margined positions faced tens of billions in margin calls as gas prices went vertical — economically their hedges were fine, but the liquidity demands forced state backstops. OTC swaps with credit thresholds cushioned exactly this; both models carry the risk somewhere.
4 · AdvancedPricing & valuation
Pricing: the strip decomposition
A swap is a portfolio of forward purchases at each settlement, so the fair fixed price is the discount-weighted average of the forward curve over the swap's months:
What the symbols mean
- Kthe strike: the price written into the contract
- Va value
- Fthe forward or futures price
- Pa price, or a present value
- ta point in time
with volumes \(V_m\) and futures/forwards \(F_{0,m}\) (interpolated and basis-adjusted for the exact index). Seasoned-value = discounted sum of (current strip − contract fix) per remaining period. The curve does all the work — swaps inherit contango/backwardation economics wholesale.
Averaging fine print
Settlements reference the average of daily prints within each month: partially elapsed periods blend realised averages with remaining forwards (as in Asian options), and hedging desks carry intramonth "fixing risk" managed with daily futures rebalancing.
xVA and contingent exposure
Uncollateralised corporate swaps generate large potential exposure on multi-year energy strips; CVA/FVA make up material parts of quoted spreads. Wrong-way risk is vivid: an airline's default probability rises exactly when oil (its swap liability) spikes — priced via correlated exposure-default simulation.
Beyond vanilla
Swaptions on strips, extendables, and volumetric flexibility (swing) add optionality priced on forward-curve models with jump/spike components (gas, power). Freight (FFAs), emissions (EUA), and even weather complete the family — anything with an index can be swapped.
The formulas above are standard textbook formulations, simplified for teaching. They explain the mechanism — they are not a valuation tool, and they will not reproduce a dealer’s price.
5 · Desk notesHow practitioners think about it
Now say it back
Close the page and give Commodity Swap in four sentences. It takes a minute and it is the only way to find out whether reading it was enough.
- Who wants what — two parties wanted opposite things badly enough to write it down.
- What the contract obliges, and when — not the payoff; the obligation.
- Where the money comes from — name the source, or you have described a hope.
- What makes it lose — the ordinary way, not the dramatic one.
Put Commodity Swap beside any other instrument →
Where this instrument shows up elsewhere
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