Managing Palm Oil risks with futures – Pricing and Hedging Example
CME Group offers a range of Palm Oil products, including its flagship Malaysian Crude Palm Oil Calendar futures (CPO). The contract is financially settled based on the Bursa Malaysia Derivatives (BMD) Crude Palm Oil futures. The final settlement price of CPO contract is the monthly average of the settlement prices for the third nearby BMD Crude Palm Oil futures contract converted to U.S. dollars. Underlined by a well-known benchmark market, CME Group’s Crude Palm Oil products represent crude palm oil priced in U.S. dollars and serve as a more precise tool for entities engaged in international trades. Firms involved in other parts of the supply chain may also find the contracts useful as a proxy hedge.
Key Contract Characteristics of CME Malaysian Crude Palm Oil Calendar futures
|Malaysian crude palm oil cAleNdAr FUTURES|
|Contract Size||25 MT|
|Settlement Type||Financial – Final settlement is based on the average of the settlement prices for the third forward month BMD FCPO contract for each trading day in the contract month converted to U.S. dollars using the Kuala Lumpur USD/MYR Reference Rate.|
|Price Quotation||U.S. dollars per metric ton|
|Minimum Price Fluctuation||$0.25 per metric ton|
Pricing and Hedging Example
There are different trading and hedging strategies, and each market participants may have their own preferences, but the following hypothetical example shows how a palm oil exporter could utilize the CME Group futures markets to fix the sales price of their exports.
Scenario: An exporter sells crude palm oil on an FOB Malaysia basis and agrees with its buyer to link the export price to the settlement price for CME Group futures.
In February, the exporter sells 30,000 mt physical crude palm oil to be delivered four months later. Instead of negotiating a fixed price, the two parties decide to benchmark the sale against the CME Malaysian Crude Palm Oil Calendar futures (CPO) and these prices are published daily on the USD Malaysian Crude Palm Oil Calendar page. The sale price is CPO June contract final settlement price plus $5/mt premium.
At the same time, in the futures market the exporter sells 1,200 lots of June futures (equivalent to 30,000 mt of palm oil) contracts at $1,180/mt. The futures contract is financially settled based on BMD Crude Palm Oil futures settlement price. The final settlement price is equal to the monthly average of BMD Crude Palm Oil futures third forward month daily settlement converted from ringgit to U.S. dollars.
The price of the futures falls and this results in a final settlement price for June futures of $1,255 per metric ton. The exporter therefore sells 30,000 mt of crude palm oil to its buyer at $1,260/mt ($1,255/mt futures price + $5/mt premium) with a revenue of 37.8 million dollars.
In the derivative market, the 1,200 lots June futures contracts final settles at $1,255/mt, making a loss of $2.25M (-$75 x 1,200 lots x 25 mt).
The total revenue of the crude palm oil sale with the hedge is $35.55M or $1,185 per ton. This equals the June futures price of $1,180 the firm hedges at in February, plus the $5 premium.
|February||Initiates sale of 30,000 mt of physical crude palm oil to its buyer at CME CPO futures June contract final price + $5/mt premium||Sells 1,200 lots of CME CPO futures June contracts at a price of $1,180/mt|
|June||Finalizes sale of 30,000 mt of crude palm oil at $1,260/mt, which is a combination of CME CPO futures final price $1,255/mt and premium $5/mt.||1,200 lots of CME CPO futures expires at the end of June. The final settlement price is $1,255/mt.|
|Cost and Profit/Loss||Sale of physical cargo: 30,000 mt x $1,105/mt = $37.8M||Loss: 1,200 lots x 25 mt x ($1,180 /mt – $1,255/mt) = $2.25M||Total Revenue (net sales price): $37.8M - $2.25M (futures loss) = $35.55M|
All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.