regardless of whether one owns the particular commodity involved. When dealing in futures, it is unnecessary to make or receive deliv-ery of the actual commodity providing that the future isn’t bought or sold during its delivery month. A previous purchase or sale can be cancelled out at any time by an equal offsetting sale or purchase, respectively. Done prior to the delivery month, the trades cancel out, with no delivery of the commodity. Less than about 2% of all futures contracts are ever settled through deliveries. Prices are determined solely by supply and demand; if there are more buyers than sellers, prices will go up, and vice versa. Each futures exchange has its own clearinghouse through which members must clear their trades. This simplifies futures trading by allowing parties to settle their transactions with the clearinghouse, rather than with each individual party with whom they’ve traded. The justification for futures trading is that it provides the means for those who produce or deal in cash commodities to hedge, or insure, against unpredictable price changes. Following is an ex-ample of how a pellet producer might use futures to hedge against price uncertainty. pellet Futures short hedge A wood pellet producer has just entered into a contract to sell 50,000 tonnes of pellets, to be delivered in three months. The sale price will be based on the market price of pellets on the day of de-livery. At the time of signing the agreement, the spot price for pellets is € 135/tonne, and the price of pellet futures for delivery in three months € 132/tonne. To lock in the selling price at € 132/tonne, the producer enters a “The short hedge allows the producer to reduce risk and make a modest profit, regardless of market fluctuations.” short position in an appropriate number of pellet futures contracts. If each standard pellet futures contract is for 1,000 tonnes, the pro-ducer must short 50 futures contracts. By entering the hedge, the producer will be able to sell the 50,000 tonnes of pellets at € 132/tonne for a total amount of € 6,600,000. Let’s see how this is achieved by looking at scenarios in which the price of pellets makes a significant move upwards or downwards by the delivery date. scenario #1 Pellet spot price falls by 10% to € 118/tonne by the delivery date As per the sales contract, the producer sells the pellets at € 118/ tonne, resulting in net sales proceeds of € 5,900,000. At the delivery date, the pellet futures price has converged with the pellet spot price and is now € 118/tonne. The short futures posi-tion was entered into at € 132/tonne, for a gain of € 14/tonne ( € 132/ tonne – € 118/tonne). With 50 contracts covering 50,000 tonnes, the total gain from the short futures position is € 700,000. Together, the gain in the pellet futures market and the amount realised from the sales contract totals € 6,600,000, equivalent to selling 50,000 tonnes of pellets at € 132/tonne. Canadian BIOMASS 29
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