How do commodity swaps provide index exposure without storing physical goods?

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AcadiFi · Accepted Answer

A commodity swap exchanges a fixed commodity price for a floating index price on a notional quantity. Brackstone Regional Airways consumes 72 million gallons of jet fuel annually. To hedge 60% of 2027 consumption, Brackstone enters a swap with Merivale Commodities: Brackstone pays $2.78/gallon fixed and receives the monthly average Platts Gulf Coast Jet A index on 3.6 million gallons per month. No physical delivery occurs — only cash settlement. If the index averages $3.12/gallon in August, Brackstone receives $0.34 × 3.6M = $1.224M, offsetting higher spot purchases at the airport. If fuel drops to $2.40, Brackstone pays $0.38 × 3.6M = $1.368M, but benefits from cheaper physical fuel at the pump. ```mermaid flowchart LR A[Brackstone
Fixed Payer] -->|$2.78/gal Fixed| B[Merivale
Floating Payer] B -->|Platts Jet A Index| A A -->|Spot Purchase| C[Refinery] ``` Merivale hedges by taking offsetting positions in NYMEX heating oil futures (jet fuel's closest liquid proxy) and by booking opposite trades with producers who want to lock in selling prices. Residual basis risk — the spread between Gulf Coast jet and NYMEX heating oil — remains on Merivale's books. Energy swaps dominate commodity volumes, but metals, agriculturals, and freight indices (Baltic Dry) also trade actively. FRM candidates should know the basis risk, roll cost, and contango/backwardation mechanics.

How do commodity swaps provide index exposure without storing physical goods?

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