Tools

MSDS-TDS

NGL - Risk Management Tool: Price Cap

A Price Cap contract allows a customer to receive a credit or cash settlement from the seller of the Cap contract at the end of each month if the month's OPIS average price at a certain physical location is greater than a predetermined price (the 'Cap' price) to which the parties mutually agree when entering into the cap contract.

Example:

On June 8, your company elects to enter into a Cap transaction on 100,000 gallons per month, October through March, at Mt. Belvieu.

The cap price is set by mutual agreement at $0.60 per gallon and at that price, based upon conditions in the various propane trading locations at the time, a premium of $0.05 per gallon is charged for the cap.

Upon execution of the agreement, your company is invoiced for the $30,000 premium (100,000 gallons per month X 6 months X $0.05/gallon). For October the OPIS weighted-average price for Mt Belvieu turns out to be $0.90/gallon. You would receive a check or a credit to your account for $30,000 (100,000 gallons X $0.30, which is the month's average of $0.90 less the strike price of $0.60). This payment helps offset the additional amount (above $0.60/gallon) you might have paid on a 'spot' basis at your usual terminal to purchase the propane you needed, bringing your final propane cost per gallon back to $0.60 (plus the cap premium). On the other hand, if the average price at Mont Belvieu for the month (as reported by OPIS) turns out to be $0.55 per gallon, you would receive no payment, since price conditions allowed you to buy propane that month at a price below the $0.60/gallon cap price that had been agreed upon. It is important to note that your premium is not refunded; it is analogous to the premium paid for automobile insurance that goes unused in the event that no accidents occur.

General Requirements/Conditions:

Parties must verify to each other's satisfaction that each of them is legally qualified to enter into financially-settled commodity instruments.
Parties agree to a financial master contract framework (the ISDA) and establish mutually-acceptable credit terms for financially-settled instruments.
Parties agree to a cap price, benchmark physical pricing location (for which OPIS price assessments are published), and number of months that the contract will cover; customer pays the corresponding (non-refundable) premium.
The contract is settled in cash each month against the monthly OPIS average price for the selected location.