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NGL - Risk Management Tool: Price Collar

six bags each filled with different types of nuts

A Collar Contract allows a customer to keep its costs within an agreed range, effectively putting a "Collar" around purchase prices. A Collar represents the combination of a Cap contract and a Floor contract. The customer often chooses the floor price, while the Cap price is determined by the other party based upon current conditions in various propane trading locations and is disclosed before the parties enter into the contract.

Collar (Zero-cost)

An important feature of a zero-cost collar is that it requires no premium payment. Rather than paying a premium, you agree to a minimum price, or floor. Perhaps the most attractive feature of this structure is that the only time you effectively pay for price protection is when you can best afford it when prices are below the floor.

A reference physical location (index) for which daily OPIS assessments are published (e.g. Conway, Mt. Belvieu) is agreed upon; the price of propane at this reference location is intended to correspond to your propane costs for the purpose of the collar contract. If the index price at the chosen location is between the cap price and the floor price for a given month, no payments are exchanged.

Example:

On July 5th your company enters into an agreement setting up the following 'collar': Floor price $0.45/gallon; Cap price $0.65; Volume 100,000 gallons per month, October through March, referenced to the Mt Belvieu OPIS price assessment.

During the month of October, if average of the daily OPIS published price assessments for Mt. Belvieu turned out to be $0.73 per gallon, you would receive a check or a credit to your account for $8,000 (100,000 gallons X $0.08: month's average $0.73/gallon less Cap Price of $0.65/gallon). On the other hand, if the average OPIS Mont Belvieu price for the month turns out to be $0.43 per gallon, your company will receive an invoice for $2,000 (100,000 gallons X $0.02: Floor Price $0.45 less the $0.43 average price for the month). If the price remains within the 'collar' range no credits or liabilities are recorded with regard to the collar contract.

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 contract cap and floor prices, benchmark physical pricing location (a location/terminal for which daily OPIS assessments are published), and the months that the collar contract will cover.
The contract is settled in cash each month against the monthly average of OPIS daily assessments for the location specified in the contract.