Fuel Hedging and Risk Management - Gajjala Vishnu N.

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Precious metals. Metals such as gold, silver, platinum, palladium, rhodium, etc. can be classified as precious metals. This classification derives from their historical usage as currency, and their scarcity relative to other metals.

      2. Base metals/industrial metals. Metals such as copper, aluminum, zinc, nickel, lead, and tin are some of the major base metals traded in global markets. The name “base metals” derives from their tendency to oxidize or corrode, as opposed to noble or precious metals. In mining, the term “base metals” generally refers to non-ferrous metals, excluding precious metals, while the term “industrial metals” expands the definition to include other commonly used metals such as iron and steel.

      3. Energy commodities. Commodities that are used for the production of energy come under this category. They include crude oil, derivatives of crude oil such as naphtha, gasoline, gasoil, heating oil, and fuel oil, in addition to natural gas, coal, electricity, biodiesel, and other commodities. Petrochemicals, emissions, and freight, which have close linkages to the energy market, can also be considered as energy commodities.

      4. Agricultural commodities. Agricultural commodities encompass a wide range of commodities produced by farming. They can be further divided into sub-classes, based on their usage, availability, and the similarity of their markets.

      a. Food grains. Commodities mainly used for human consumption, like rice, wheat, corn, etc.

      b. Edible oils and oilseeds. Oils fit for human consumption, including soybean oil, palm oil, soybeans, soybean meal, rapeseed (canola) oil, sunflower oil, etc.

      c. Livestock. Live animals, which are mainly live cattle, feeder cattle, and lean hogs.

      d. Soft commodities. Other agricultural commodities such as cotton, coffee, cocoa, sugar, orange juice, rubber, etc.

      Increasingly, there are linkages between classes of commodities such as energy and agricultural commodities. Commodities such as sugar or palm oil are used not only as food, but also to generate energy in the form of biodiesel. However, we use the aforementioned classification as it is based on the primary usage of the commodity and the major driver of demand for that particular commodity.

      ENERGY COMMODITIES

      Energy commodities come in different physical forms: solids such as coal and wood, liquids like petroleum, and gases such as natural gas and propane and butane (that are converted into Liquefied Petroleum Gas (LPG)). Most energy commodities in use are hydrocarbons, although nuclear energy and hydroelectric power are notable sources of power that are not hydrocarbon-based.

The main sources of primary energy are oil, natural gas, coal, nuclear energy, hydroelectric power, and renewables. Many of these primary sources are used in the generation of electricity, a secondary form of energy. The International Energy Agency (IEA) provides details on the supply and consumption of oil and other energy commodities. A breakdown of the total primary energy supply (TPES) of the world is shown in Figure 1.1. Oil and coal are the biggest sources of energy, with natural gas not far behind. Of these forms of energy, oil, coal, natural gas, and biofuels are traded in regional and global markets.

FIGURE 1.1 Total primary energy supply for 2012; TPES totaled 13,371 Mtoe (million tons of oil equivalent)

      Source: International Energy Agency, © OECD/IEA 2014, Key World Energy Statistics, IEA Publishing; modified by John Wiley and Sons Ltd. License: www.iea.org/t&c/termsandconditions.

The total final consumption of energy provides a picture of the end uses of primary energy (without including backflows from the petrochemical industry). It can be inferred by comparison with primary energy supply that a significant proportion of primary energy sources, especially coal and natural gas, are converted into electricity for final use. As per the IEA, 63.7 % of oil is consumed for transportation, while industrial use of coal accounts for 80 % of its annual consumption (Figure 1.2).

FIGURE 1.2 Total final consumption for 2012; TFC totaled 8979 Mtoe (million tons of oil equivalent)

      Source: International Energy Agency, © OECD/IEA 2014, Key World Energy Statistics, IEA Publishing; modified by John Wiley and Sons Ltd. License: www.iea.org/t&c/termsandconditions.

      Let us now briefly consider individual energy commodities, starting with crude oil.

      Crude Oil

      Crude oil or petroleum, derived from the Latin: petra (rock) + oleum (oil), refers to the thick, usually dark-colored liquid that occurs naturally in different parts of the world and is commonly retrieved by drilling. Petroleum is a fossil fuel, which was formed when a large number of dead organisms were buried under sedimentary rock and subjected to enormous heat and pressure over millions of years. Crude oil is the most prominent of the hydrocarbon-based fuels, compounds composed mainly of carbon and hydrogen in varying proportions.

      Since crude oil on its own is not of much use and needs to be processed for most modern applications, the value of crude oil is derived from the value of the underlying refined products that are obtained after processing. The products that can be obtained from refining a particular grade of crude oil depend on the chemical characteristics of the crude oil. Since crude oil obtained from an oil well will differ slightly in quality from oil drilled from any other well, it is instructive to look at the overarching physical properties and characteristics that determine the value of a particular grade of crude.

      The major properties of crude oil that are referenced in most contracts and specifications are the density, sulfur content, viscosity, pour point, volatility, water content, and sediment and other impurities. Other properties that are applicable to oil products include the flash point, cloud point, stability, dye, etc.

      Density is measured using the American Petroleum Institute (API)s gravity scale, which is a measure of how much heavier or lighter the petroleum liquid is compared with water. A reading of above 10 indicates that the liquid is lighter than water and floats on it. Crude oil with a high API gravity value is referred to as light crude oil and would yield a higher percentage of lighter or less-dense products such as gasoline and kerosene upon refining. Crude oils with a low API gravity value are termed heavy crudes and are more difficult to refine, yielding lesser quantities of the high-value lighter products.

      Sulfur is an undesirable impurity as it is corrosive and foul smelling, and it needs to be removed during the refining process. Crude oils with a sulfur content of less than 0.5 % are referred to as “sweet” crude oils, while those with a sulfur content greater than 0.5 % are termed “sour” crudes.

      Viscosity is a measure of the thickness of the fluid or the resistance that it offers to pouring. It is measured in centistokes or Saybolt universal seconds. The pour point is the lowest temperature at which the crude oil retains its flow characteristics and below which it turns semi-solid. These measures are essential to determine the means of storage and transportation for liquids.

      Volatility of crude oil and other products is measured using the Reid vapor pressure test and is important for handling and treatment considerations. Vapor pressure is especially important for gasoline as it affects starting, warm-up, and vapor locking tendency during use. Water content and sediment content are measured, as they are indicative of the effort needed to remove these impurities.

The main crude oil benchmarks are West Texas Intermediate (WTI) Crude Oil, which is a US crude oil, and Brent Crude Oil (North Sea crude oil). Both of these crudes are light sweet crude oils, where the API gravity is greater than 31.1°. Dubai Crude

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