Commodity Swap

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.

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.

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:

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.