THERMAL COAL AS AN ENERGY PRODUCT
Thermal or Energy Coal is by far the cheapest fossil fuel available in the world. It is used widely in power generation and general industries such as cement, fertilizers, solvents, pharmaceuticals… In addition, coal can be easily converted into transportable gas or liquid fuels for energy.
Although the usage of coal has been under scrutiny due to environmental concerns, with the introduction and progress of clean coal technology, coal is expected to continue playing an important role in years to come.
Thermal Coal as a Commodity
Coal is now a fully commoditized product that is traded actively in U.S, Europe and Asia Pacific. Financial derivatives contracts are also traded in large volume by power utilities, coal producers, trading companies, and banks to hedge or lock in profits.
The following derivative instruments are traded in the market:
- Fixed price forward contract
This is a standardized contract used to sell and buy coal in the future at a price fixed on the transaction date. Forward contracts can be used as instrument to buy or sell physical coal as well as a financial instrument for hedging or speculating purposes.
- Index-linked forward contract
A forward contract whereby the price is not fixed at some specific level but is linked to Index.
This is purely a paper hedging instrument. It is an agreement whereby two parties agree to exchange a floating price for a fixed price over a specified period. This instrument allows players to manage price risks by transferring floating price to fixed price and vice versa.
A spread is a trading technique derived from forward and swaps trading. It refers to buying or selling the differential between contract prices of two different periods (for example prices of May and June), which is called Inter-month spread; or differential between prices of two related products (for example price of coal and electricity, which is called dark spread); or differential between prices of coal from different geographic regions (for example price of coal at South Africa versus price of coal at Australia’s port).
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