Forward and Swap Fuel Oil Prices

11 October 2008

What is forward fuel oil price? What is swap fuel oil prices? How do they differ? Are there confusions in using the term "forward fuel oil prices" by the Energy Market Authority of Singapore (EMA)? What is the fair price to be used for evaluating electricity rates?

What is Forward and Swap Fuel Oil Prices?
They are just derivatives of oil trades similar to the Futures Oil prices traded in the New York Mercantile Exchange (NYMEX).

Forward fuel oil prices (FFOP) are quoted in a forward market. Unlike the NYMEX Futures market, the forward market is less price transparent because the forward contracts are traded informally between principals such as big oil companies who are not obliged to publish the details of any deal that is done.

Swap fuel oil prices (SFOP) are quoted in a swap market. It is a relatively new form of OTC derivative trading market. It is very much like the NYMEX Futures except it is commonly used by banks & big oil companies nowadays; hence, big quantities with relatively few trades. The oil trades are quoted in metric tonnes instead of barrels. Like FFOP, it is still a private agreement between two parties to exchange cash at pre-arranged dates in the future according to an agreed price formula. But unlike FFOP, the SFOP quotations can be found in public exchanges such as ICE; also, SFOP does not involve physically delivery of fuel oil at the end of the contract. More details about FFOP and SFOP can be found here.

Confused Terms Used
The EMA's website clearly shows that EMA has been using the term Forward Fuel Oil Price (FFOP) for evaluating the electricity rate. This term is also being used by EMA in all its clarifications in the press and newspapers. But if one clicks the link on FFOP in EMA's website, one will be led to a published SWAP quotation from ICE. Is EMA confused between the terms used?

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The ICE's Quotation
The ICE's quotation for 4th quarter 2008 which is quoted in July 2008 is shown attached. They are quoted in US$ per metric tonne. To convert from metric tonne to numbers of oil barrel, one would have to divide it by 6.6.

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The quotation clearly shows that there are not more than 300 bids/offers and 11 deals were settled in the month of July 2008. The highest quote was US$ 795 per metric tonne (or US$ 120 per barrel) and the lowest quote was US$ 698 (or US$ 105 per barrel).

Which Market is Fair?
There just isn't a market price that can be used to accurately predict the fuel oil price to be used in the future. This is because NYMEX futures, forward, swap, options are all derivative instruments of the spot oil market. They are only good for use as hedging tools. They are all subject to manipulation, in particular, the FFOP and SFOP because of the private dealings and the small numbers of active trades.

Among the markets, NYMEX futures is the most transparent and most actively traded; therefore, a better market. Alternatively, we can use spot fuel oil price.

SP & Power Generating Companies would never lose out in any pricing that EMA has adopted and agreed upon. This is because SP & Power Generating Companies have the means to hedge such price against any future price variation like what SIA has been doing all the while.

If EMA wanted to be fair to both SP & Power Generating Companies and the consumers, they could always do a price adjustment at the end of a period, like the Public Utilities Board (PUB) used to before 2000. Using SFOP or FFOP to evaluate the electricity rate is not necessary fair to the consumers.

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