White Papers Managing Forward Curves in a Complex Market | Page 2

Introduction Any company that owns commodities, either through production or merchant activities, needs to know not only the current value of those commodities based on market prices, but also needs to develop a view of the future value of those commodities during the time that they are projected to be held in inventory. Additionally, agreements to purchase commodities in the future must be accounted for, not only at their agreed or projected purchase price, but also during their anticipated holding period. Commodity prices are constantly changing and are driven by market forces that are virtually impossible to predict with any degree of certainty. As such, accurately forecasting costs and price exposures is difficult at best, and particularly so now, given the rapidly changing supply and demand patterns that define the global commodity complex. Huge growth in demand for all commodities in Asia, the rapid rise of agricultural exports from developing countries in the Asia-Pac region, and the shale revolution that is driving unprecedented growth in US oil production, are all examples of the new dynamics that have fundamentally altered price formation in markets around the world. In this globalized and increasingly interconnected market-place, which is being constantly buffeted by economic uncertainty, predicting future prices is more difficult, but perhaps more important, than ever. Along with ever shifting supply and demand patterns, new markets, trading hubs, and storage facilities have opened, creating new trading locations where none existed just a few short years ago. Though many have already become recognized pricing centers, others are, and continue to be, rather illiquid, with few transactions and little knowledge in the broader market as how to price those locations on a future basis. Even in areas and markets that have had a long and sustained history of prices, new productive regions (such the massive growth in natural gas production from the Marcellus Shale in the Northeast US, for example) can create a lasting and dramatic © Commodity Technology Advisory LLC, 2014 change in futures prices. Future price prediction then becomes difficult as the sudden change in fundamentals produces prices that are uncorrelated from historical activity. With these market changes, the ability to interpret market activity and measure the future impact of anticipated developments becomes more imperative. Defaulting to a common exchange price curve or attempting to simply project historical prices forward is insufficient in this dynamic environment as it ignores the both the global impact of changing supply and demand patterns and the growing inter-relationships amongst commodities and markets. While some wholesale spot markets that trade on exchanges, such as Henry Hub’s natural gas contract, are well established, highly liquid and somewhat seasonally predictable, the majority of commodity trading locations and markets around the globe are not, and exchange data is either not directly reflective or is unreliable. It’s these imperfect, inefficient and sometimes insufficiently liquid wholesale spot markets where the need for careful and thoughtful modeling of future prices, or the “forward curve”, becomes an essential exercise in risk management and financial reporting for commodity trading companies. In this paper, we’ll examine the complexities associated with the development, and the specific uses, of forward price curves. In addition, we’ll review a sophisticated technology available from DataGenic – the Genic CurveBuilder - that can automate and reduce the complexity associated with the development of forward price curves.