Question

1)   An oil refinery company wants to hedge the risk against the rise in the oil price for purchase in the December of 2018. Thus, it enters into the oil futures market now. The current futures price of oil for delivery in January 2019 is $48/barrel. In December 2018, the refinery closes out its crude oil futures position when the market futures price of oil for delivery in January 2019 is $56/barrel. The company then purchases the oil at the market price of $57/barrel. What is the effective price that the refinery pays for crude oil per barrel?

2) It is October. Suppose the price for the March and April (of the next year) natural gas futures contracts is $2.552/MMBtu and $2.308/MMBtu, respectively. If you learned that there were less major tropical storms in the Gulf Coast area than normal years, what position in March and April contracts would you take?

Answer 1

In case of multiple questions being posted, as per rule only first question may be answered unless explicitly stated that all questions need to answered

1) Since the oil refinery wants purchase oil in Dec 2018 and also wants hedge against the rise of price, it will take a long position in Jan 2019 futures contract. We know that long position in future contract will gain when future price rises, As given in this question future price of Jan 2019 futures has increased from current price of $48 / barrel to Dec 2018 price of $56 / barrel, so there will gain from hedge

Net gain from hedge = Price of Jan 2019 Futures in Dec 2018 - Current Price of Jan 2019 Futures = $56 - $48 = $8 / barrel

Purchase price of oil in Dec 2018 = $57 / barrel

Effective price paid by refinery = Purchase price of oil in Dec 2018 - Net gain from hedge = $57 - $8 = $49 / barrel

Hence Effective price paid by refinery = $49 / barrel