Commodity Derivatives, 2nd Edition

CHAPTER 1Fundamentals of Commodities and Derivatives

After the publication of the first edition of this text, many of the author's friends not involved with financial markets often asked, ‘what are commodities’? Like many innocent questions, they are often very difficult to answer. In one sense, they are largely unprocessed or semi‐processed goods, which are either consumed or can be processed and then resold. However, this definition will not always universally apply; for example, freight and carbon emission markets do not easily fall within this category.

In general terms, commodities can be classified under different headings:

Energy markets

• Crude oil and refined products (e.g. WTI/Brent, gasoline)
• Power and natural gas
• Natural gas liquids (e.g. propane and butane)
• Coal

Industrial metals

• Copper, aluminium

Precious metals

• Gold, silver

Agricultural products

• Grains
• Softs (e.g. coffee)
• Livestock

‘Specialty’ markets

• Forest products (e.g. pulp and recovered paper)
• Carbon emissions
• Weather
• Freight

1.1 MARKET OVERVIEW

Figure 1.1 is a ‘big picture’ overview of commodity markets.

In this diagram there are two main segments, the physical and the financial markets. The diagram was designed without a specific product in mind, but if the reader prefers some context, it may be helpful to think of a popular commodity such as crude oil. Within the physical side of the market there will be three main participants: producers, refiners, and consumers. In addition, trading houses ...