Commodity Swap

Traders use commodity swap to hedge against price fluctuations in commodity prices, commonly energy and agriculture commodities

The advantage of being linked with a commodity swap is that the user can secure a maximum price to the commodity and agree to pay a financial institution a fixed amount. In return, he/she gets payments based on the market price of the commodity. Fixed-floating and commodity-for-interest are the two types of commodity swaps commonly seen.

Let’s think of a practical example, the case of airlines. Airlines, heavy users of oil, will often highly benefit by entering into a swap deal. In swap contracts, airlines companies agree to make a series of fixed payments at a pre-determined frequency, say every three months for two years. In fact, airlines will buy the actual oil from spot market; however they receive payments on agreement dates as determined by an oil price index.