Price risk management in the copper market using commodity derivatives and options strategies

Metals price risk management is a key issue related to financial risk in metal markets because of uncertainty of commodity price fluctuation, exchange rate, interest rate changes and huge price risk either to metals’ producers or consumers. Thus, it has been taken into account by all participants in metal markets including metals’ producers, consumers, merchants, banks, investment funds, speculators, traders and so on. Managing price risk provides stable income for both metals’ producers and consumers, so it increases the chance that a firm will invest in attractive projects. The purpose of this research is to evaluate risk management strategies in the copper market. The main tools and strategies of price risk management are hedging and other derivatives such as futures contracts, swaps and options contracts. Hedging is a transaction designed to reduce or eliminate price risk. Derivatives are financial instruments, whose returns are derived from other financial instruments and they are commonly used for managing financial risks. Although derivatives have been around in some form for centuries, their growth has accelerated rapidly during the last 20 years. Nowadays, they are widely used by financial institutions, corporations, professional investors, and individuals. This project is focused on the over-the-counter (OTC) market and its products such as exotic options, particularly Asian options. The first part of the project is a description of basic derivatives and risk management strategies. In addition, this part discusses basic concepts of spot and futures (forward) markets, benefits and costs of risk management and risks and rewards of positions in the derivative markets. The second part considers valuations of commodity derivatives. In this part, the options pricing model DerivaGem is applied to Asian call and put options on London Metal Exchange (LME) copper because it is important to understand how Asian options are valued and to compare theoretical values of the options with their market observed values. Predicting future trends of copper prices is important and would be essential to manage market price risk successfully. Therefore, the third part is a discussion about econometric commodity models. Based on this literature review, the fourth part of the project reports the construction and testing of an econometric model designed to forecast the monthly average price of copper on the LME. More specifically, this part aims at showing how LME copper prices can be explained by means of a simultaneous equation structural model (two-stage least squares regression) connecting supply and demand variables. A simultaneous econometric model for the copper industry is built: {█(Q_t^D=e^((-5.0485))∙P_((t-1))^((-0.1868) )∙〖GDP〗_t^((1.7151) )∙e^((0.0158)∙〖IP〗_t ) @Q_t^S=e^((-3.0785))∙P_((t-1))^((0.5960))∙T_t^((0.1408))∙P_(OIL(t))^((-0.1559))∙〖USDI〗_t^((1.2432))∙〖LIBOR〗_((t-6))^((-0.0561))@Q_t^D=Q_t^S )┤ P_((t-1))^CU=e^((-2.5165))∙〖GDP〗_t^((2.1910))∙e^((0.0202)∙〖IP〗_t )∙T_t^((-0.1799))∙P_(OIL(t))^((0.1991))∙〖USDI〗_t^((-1.5881))∙〖LIBOR〗_((t-6))^((0.0717) Where, Q_t^D and Q_t^Sare world demand for and supply of copper at time t respectively. P(t-1) is the lagged price of copper, which is the focus of the analysis in this part. GDPt is world gross domestic product at time t, which represents aggregate economic activity. In addition, industrial production should be considered here, so the global industrial production growth that is noted as IPt is included in the model. Tt is the time variable, which is a useful proxy for technological change. A proxy variable for the cost of energy in producing copper is the price of oil at time t, which is noted as POIL(t ) . USDIt is the U.S. dollar index variable at time t, which is an important variable for explaining the copper supply and copper prices. At last, LIBOR(t-6) is the 6-month lagged 1-year London Inter bank offering rate of interest. Although, the model can be applicable for different base metals' industries, the omitted exogenous variables such as the price of substitute or a combined variable related to the price of substitutes have not been considered in this study. Based on this econometric model and using a Monte-Carlo simulation analysis, the probabilities that the monthly average copper prices in 2006 and 2007 will be greater than specific strike price of an option are defined. The final part evaluates risk management strategies including options strategies, metal swaps and simple options in relation to the simulation results. The basic options strategies such as bull spreads, bear spreads and butterfly spreads, which are created by using both call and put options in 2006 and 2007 are evaluated. Consequently, each risk management strategy in 2006 and 2007 is analyzed based on the day of data and the price prediction model. As a result, applications stemming from this project include valuing Asian options, developing a copper price prediction model, forecasting and planning, and decision making for price risk management in the copper market.

Induction of Microalgal Lipids for Biodiesel Production in Tandem with Sequestration of High Carbon Dioxide Concentration

There is no doubt that sufficient energy supply is indispensable for the fulfillment of our fossil fuel crises in a stainable fashion. There have been many attempts in deriving biodiesel fuel from different bioenergy crops including corn, canola, soybean, palm, sugar cane and vegetable oil. However, there are some significant challenges, including depleting feedstock supplies, land use change impacts and food use competition, which lead to high prices and inability to completely displace fossil fuel [1-2]. In recent years, use of microalgae as an alternative biodiesel feedstock has gained renewed interest as these fuels are becoming increasingly economically viable, renewable, and carbon-neutral energy sources. One reason for this renewed interest derives from its promising growth giving it the ability to meet global transport fuel demand constraints with fewer energy supplies without compromising the global food supply. In this study, Chlorella protothecoides microalgae were cultivated under different conditions to produce high-yield biomass with high lipid content which would be converted into biodiesel fuel in tandem with the mitigation of high carbon dioxide concentration. The effects of CO2 using atmospheric and 15% CO2 concentration and light intensity of 35 and 140 µmol m-2s-1 on the microalgae growth and lipid induction were studied. The approach used was to culture microalgal Chlorella protothecoides with inoculation of 1×105 cells/ml in a 250-ml Erlenmeyer flask, irradiated with cool white fluorescent light at ambient temperature. Using these conditions we were able to determine the most suitable operating conditions for cultivating the green microalgae to produce high biomass and lipids. Nile red dye was used as a hydrophobic fluorescent probe to detect the induced intracellular lipids. Also, gas chromatograph mass spectroscopy was used to determine the CO2 concentrations in each culture flask using the closed continuous loop system. The goal was to study how the 15% CO2 concentration was being used up by the microalgae during cultivation. The results show that the condition of high light intensity of 140 µmol m-2s-1 with 15% CO2 concentration obtain high cell concentration of 7 x 105 cells mL-1 after culturing Chlorella protothecoides for 9 to 10 day in both open and closed systems respectively. Higher lipid content was estimated as indicated by fluorescence intensity with 1.3 to 2.5 times CO2 reduction emitted by power plants. The particle size of Chlorella protothecoides increased as well due to induction of lipid accumulation by the cells when culture under these condition (140 µmol m-2s-1 with 15% CO2 concentration).