Ethanol Futures _ Options Brochure - Ethanol by liwenting

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									                    Ethanol
                    Futures and Options




               a t t h e N e w Yo r k B o a r d o f T r a d e




A XA XA XA XA XA XA XA XA XA XA XA XA XA XA XA XA
The New York Board of Trade® (NYBOT®) was created in 1998 as the parent


company of the Coffee, Sugar & Cocoa Exchange, inc. (CSCE) and the New York


Cotton Exchange (NYCE®) . The CSCE has been the designated exchange for cof-


fee, sugar, cocoa and ethanol contracts, while the NYCE, with its subsidiaries and


divisions, has served as the designated exchange for cotton, FCOJ, financial and

index products. As of June 10, 2004, the New York Board of Trade will become


the sole designated futures and options exchange for all of the products traded


previously on the CSCE and NYCE. Until that time ethanol futures and options are


listed on the CSCE.
What is Ethanol?
Ethanol (ethyl alcohol) is produced by fermenting      well before the civil war in the United States and
and distilling starch crops that have been             a usage history that is even older, ethanol shares
converted into simple sugars. It has been with         much of the same road traveled by NYBOT’s
us for a long time. And now ethanol’s time has         traditional exchanges as they built the world’s
arrived – again.                                       premier futures and options markets for several
                                                       internationally traded agricultural commodities:
Ethanol can be made from any biological
                                                       cocoa, coffee, cotton, frozen concentrated orange
feedstock with enough sugar or materials that can
                                                       juice (FCOJ) and sugar.
be converted into sugar such as starch or cellulose.
Sugar cane is the predominant feedstock that is        In the first half of the nineteenth century, ethanol
converted into ethanol on a global scale. Grains       was a popular fermentation product, useful as
(corn, wheat and barley) are the second major          a beverage solvent or a lamp fuel. Yes, this is
source, with corn the primary feedstock in the         the process that also gave us the legendary jug
U.S. The European Union uses other sources such        of “White Lightning.” Right from its beginnings
as sugar beet molasses. Ethanol has historically       in the U.S., ethanol came primarily from cane
taken three major forms: fuel, industrial products     molasses (the early form of the sugar cane trade)
and beverages.                                         and grains (corn, wheat and barley). Corn had
                                                       established itself as a major domestic crop in
What does Ethanol have to do with New York
                                                       North America. Cane molasses had been a major
Board of Trade® (NYBOT®), known for its historic
                                                       trade staple from the first colonial days. Ethanol
global agricultural markets? Quite a bit actually.
                                                       today still relies on sugar and corn. Corn is a
With an economic history that stretches back
                                                       major domestic commodity and world sugar is the
                                                                        largest futures and options market
                                                                        at the New York Board of Trade.

                                                                       Fermentation of bio-feedstocks
                                                                       has been around since Biblical
                                                                       times as one of the first, value-
                                                                       added processes that made
                                                                       basic commodities worth more.
                                                                       That     same     fermentation/
                                                                       distillation process produces
                                                                       ethanol today. And ethanol has
                                                                       seen its use shift over time from
                                                                       food to function and then to fuel.
                                                                       The great growth of ethanol today
                                                                       comes from its use as a renewable
                                                                       energy source — as a gasoline
                                                                       additive (oxygenate) and stand-
                                                                       alone alternative fuel.
Regulatory mandates, environmental pressures            ranged from just below $.50/gal to around $.92
and the globalization of trade (particularly in         and the domestic price for corn-based ethanol
basic commodities) have combined to produce             has gone from a low of about $1.10/gal. to a high
a remarkable set of opportunities in the ethanol        of nearly $1.75. This represents a sizeable range
sector of the agricultural and energy industries.       of risk for everyone along the marketing chain.
One need only look at the notice on a local gas
pump in New York or Connecticut that states             Ethanol’s current and future growth prospects
“contains 10% ethanol” to realize that something        will be in the fuel sector as a gasoline additive.
significant is afoot. All of this rapid change adds      But using gasoline futures to hedge ethanol does
to instability along the ethanol supply chain.          not work well, because there is no consistent
                                                        correlation between the prices of the two markets.
Ethanol is now poised for a major expansion of          They each have different production sources,
production and consumption as a renewable fuel.         and major consumption centers in different
This impending growth and the accompanying              geographic areas. In addition, gasoline demand
price risk underscore the critical need for reliable    reflects predictable seasonal, production capacity
price discovery – exchange-traded futures and           and inventory factors, which ethanol at its current
options contracts for ethanol.                          stage of growth does not mirror.


Whydoes ethanol need a                                  Ethanol prices also correlate poorly with corn and
                                                        sugar. In the last three years while corn prices have
futures and options market?                             risen sharply, sugar has cycled higher and lower
                                                        and ethanol prices have moved independently of
When an industry reaches a critical mass of             either feedstock. Any attempt to hedge ethanol
growth, the futures and options exchange offers         price risk against corn, sugar or unleaded gasoline,
the necessary pricing capabilities to help manage       therefore, is destined to fail. The ethanol industry
that growth and build a more mature marketplace.        suffers from a lack of quality pricing information.
Ethanol has reached such a stage.                       The ad hoc marketing chain that has evolved

According to F.O. Licht, annual growth
of ethanol production could be as much
as 10% annually over the next 10 years.
Public policy on the domestic level (the
need to meet the U.S. Clean Air Act
standards) and globally (the challenge of
the Kyoto Protocol to reduce greenhouse
gases) is driving a broad demand for the
production and consumption of ethanol as
a renewable fuel.

With the mounting regulatory and market
pressures on this emerging industry, price
volatility has increased, globally and
domestically. For example, in the past year
the global price for cane-base ethanol has

                                                  NYBOT trading floor
in response to recent regulatory pressures now         Clearinghouse Security: Each of the contracts
needs an independent price discovery process           traded at NYBOT is guaranteed by the New York
and a resulting price benchmark to navigate the        Clearing Corporation (NYCC), the designated
growth process and become a mature industry.           clearinghouse for all NYBOT markets, which
                                                       represents over a century of continuous financial
For well over a century, cotton, coffee, sugar,        integrity. Every market participant trades in the
cocoa and citrus industry representatives have         secure knowledge that they face no counterparty
joined traders and investors in the New York Board     risk and no contract uncertainty.
of Trade exchange futures and options markets
to engage in price discovery, price risk transfer      Personalized Broker Service: Experienced floor
and price dissemination for these internationally      brokers offer personal service and competitive
traded commodities. Each day, people from              pricing for specialized futures and options
around the world look to the NYBOT marketplace         trading. Brokers in NYBOT’s options markets can
for a benchmark price on traditional commodities       design and execute simple and complex options
as well as key currency and index products.            strategies and write options to implement those
                                                       strategies at very competitive prices.
As the home of the benchmark price for world
sugar, NYBOT is well-positioned to offer the           Order Processing:       Market users who have
strength and security of its futures and options       internet access to Electronic Order Routing (EOR)
markets to a value-added product of sugar —            can send orders electronically to the trading floor,
world ethanol. The obvious economic common             where they are filled in open outcry, and then
ground between world sugar and world ethanol           matched, cleared and confirmed electronically
makes the world sugar trading pit a logical home       in real time. All EOR users can enter, change
for ethanol futures and options. The NYBOT             or cancel all types of orders (including complex
exchange markets have demonstrated their deep          combination strategies). Users have real time trade
liquidity and reliability time and again, while        reconciliation in the pit and/or in the booth.
offering important capabilities and advantages:

Enhanced Open Outcry: The quality of
price discovery in NYBOT’s traditional
open outcry markets is supported by the
convenience and technical sophistication
of its new state-of-the-art trading facility
at the World Financial Center in Lower
Manhattan.

Market Integrity:       Every transaction
in the NYBOT markets is subject to
the traditional regulatory scrutiny that
characterizes the U.S. futures and options
exchanges, ensuring a fair and transparent
marketplace.



                                               NYBOT trading booths
Market Information Access: The New York Board                Today ethanol has seen its prospects renewed on
of Trade offers real time streaming data directly            a global scale. U.S. Clean Air standards and the
from the NYBOT trading floor and delivered over               international Kyoto Protocol (both dealing with
the Internet through NYBOTLive.com. Market                   carbon compounds produced by the burning of
users should visit www.nybotlive.com and                     fossil fuels) have combined to create regulatory
sample the many features of NYBOT’s direct data              support for the production and consumption
service. Market users also have access to a wide             of ethanol as an alternative fuel additive and
range of educational materials, market analysis              renewable energy source. The stage is now set for
and commentary through the NYBOT web site at                 the development of a more orderly international
www.nybot.com.                                               marketing chain to replace the limited ad hoc
                                                             arrangements that have characterized the ethanol
Food, Fuel or Function                                       industry for over a century.

For more than 150 years, powerful social, political
                                                             The Basics of Ethanol Production
and economic forces have determined the course
of the ethanol industry. Regulation has historically         Ethanol is an alcohol produced either by
defined the role of ethanol (as a beverage, an                fermentation or synthetically for use as a
industrial solvent and now as a fuel). Regulation            fuel, solvent or beverage (with the current
and powerful market forces have frequently limited           heavy emphasis on fuel). About 95% of the
the role of ethanol as a fuel. Before the Civil War,         world production of ethanol is produced by
ethanol was heavily taxed as a beverage; in 1919             fermentation from biological feedstocks that
Prohibition limited its production; in World War             contain appreciable amounts of sugar or materials
II the government claimed it as a component in               that can be converted into sugar such as starch
synthetic rubber and along the way ethanol was               or cellulose. Just as the sugar industry relies on
continually passed over as a primary fuel source.            two primary sources (sugar cane and sugar beets),
-- in spite of Henry Ford’s unequivocal support for          the ethanol industry relies heavily on two sources
it in 1904 as he designed his Model T to
run on ethanol:

“We can get fuel from fruit, from the sumac                            World Fuel Ethanol
by the roadside, or from apples, weeds,                      World fuel ethanol production by feedstock
sawdust; almost anything… and it remains
for someone to find out how this fuel can
be produced commercially – better fuel at
a better price than we now know.”                      Grains 39%




                                                                                               Sugar crops 61%

                                                  Source F.O. Licht
(sugar cane and corn). The majority of ethanol           Ethanol enters the gasoline market in several
produced outside the U.S comes from sugar cane;          ways:
domestically produced ethanol is derived mainly
from corn. Using sugar, the largest source of world      • The majority of ethanol used in the U.S.
ethanol, involves a dry-milling process in which         is “splash” blended at the gasoline “rack”
the sugar cane is ground. It can then be processed       where gasoline and ethanol are stored just
more easily, dissolving the sugar from the stalk and     before transportation to the retail station.
fibrous material and then adding yeast microbes,          Ethanol’s properties as a natural solvent make
which digest the material producing alcohol and          its transportation a challenge. It blends easily
carbon dioxide. A final step purifies the ethanol          with many substances and therefore can pick up
to the desired concentration. Other starchy crops        impurities including water in pipelines and other
such as corn involve a similar process but with          means of transportation and storage.
the additional step of adding a malting agent to
                                                         • Ethanol also comes in the form of a special
break the starches into sugar. Ethanol can also
                                                         alternative fuel in a much higher concentration.
be made from a wet-milling process. The largest
                                                         The most common form of this fuel is “E-85”, a
ethanol production facilities in the U.S. use the
                                                         mixture of 85% ethanol and 15% gasoline. This
wet-milling process. The final product is ethanol,
                                                         alternative fuel, however, does require a specially
regardless of the sugar source or process.
                                                         equipped vehicle, as does the use of hydrous
Today, ethanol is most commonly used in                  ethanol.
reformulated gasoline (RFG) to increase
                                                         • Ethanol can also be utilized in the production
octane and to improve the emissions quality of
                                                         of ethyl tertiary butyl ether (ETBE), which is about
gasoline.
                                                         42% ethanol. It is a combination of ethanol and
Fuel Ethanol takes two basic forms: anhydrous            a natural gas-based liquid, isobutylene. In this
ethanol (with all water removed) to use for              form, some of the transportation/storage problems
blending with gasoline and hydrous ethanol (with         particular to ethanol are resolved.
some water), to be used as a standalone
fuel (95% ethanol). The ethanol deliverable
against the NYBOT contract is anhydrous.
                                                                   Historical U.S. Ethanol Production
Promoters of ethanol emphasize its
role in reducing dependence on oil, its
environmental benefits, and its function as
an alternative use for farm products. The new
clean fuel requirements drive the increased
demand for ethanol. Since 1979, ethanol
production in the U.S. has increased every
year except for 1996 when corn was scarce
and high in price. U.S. ethanol production
has more than doubled in a decade and is
now growing at an even faster rate. The phase
out of MTBE and its replacement by ethanol
as an oxygenate for unleaded gasoline is a
major growth factor.
                                                       Source: Hart Downstream Energy Service
The ethanol sector has always straddled
two major industries – agriculture
and energy. As the ethanol sector
matures, it must define its own role                                 World Fuel Ethanol
and marketing chain. In 2003 more                                  Ethanol production by type
than 70% of world ethanol production
went to fuel usage. Industrial usage
accounted for 20% and beverage use
10%. The fuel usage is the one area
showing major growth while the others
have remained relatively constant over
the past five years.

Basic Supply and Demand

The ethanol story today is not unlike
the sugar story – a tale of two markets
(domestic and global). It is appropriate
that the sugar market at the New York
Board of Trade, which trades a world        Source: F.O. Licht
(Sugar No. 11) and a domestic (Sugar
No. 14) sugar contract, has given rise to
a U.S. exchange-based ethanol futures
contract.
                                                                 World Fuel Ethanol 2013
Two different tracks characterize
the ethanol market with sugar-cane
based ethanol dominating the world
ethanol market and corn-based ethanol
serving the domestic market. Projected
production patterns in the next decade
suggest that, while grain-based ethanol
(particularly corn) will continue to be
an important segment, the sugar-based
ethanol dominance is expected to
increase – particularly for the globally
traded ethanol.

Historically, ethanol shares another
characteristic with sugar – strong
regulation. Like sugar, the regulation of
ethanol has created a two-tiered market
– one a subsidized price (domestic)         Source: F.O. Licht
and the other a free market price (world). Just       • Public Policy — regulation as it affects supply
as NYBOT world sugar futures provide the              and demand of ethanol
benchmark for the unsubsidized residual sugar
market, NYBOT world ethanol futures represent         • Technology — technological improvements
the unsubsidized ethanol price.                       (that lower costs and improve efficiency) in the
                                                      production, transportation and consumption of
Domestic Supply and Demand: Spurred by                ethanol
regulatory incentives, farmer-owned facilities in
the Midwest are rapidly increasing the production     • Feedstock — the supply and demand (and
capacity of domestic, corn-based ethanol.             price) of the upstream source commodities
                                                      (sugar and grains) and downstream commodities
Supplying New York and Connecticut alone with         (unleaded gasoline)
reformulated gasoline (RFG) creates an additional
demand for about 500 million gallons of ethanol       Public Policy currently drives ethanol production
per year. California could require nearly double      and pricing. The price of U.S. - produced, corn-
that amount (900 million gallons) by next year.       based ethanol has regulatory support. While all
New Jersey, Pennsylvania, Rhode Island and other      ethanol receives a 52 cent federal excise tax
Northeast States are likely to phase out MBTE and     exemption, ethanol coming into the U.S. from
further increase the demand.                          Brazil, for example, is subject to a 54 cent/gal.
                                                      tariff to offset the excise tax exemption. This has a
Global Supply and Demand                              direct impact on Brazilian and U.S. markets —the
                                                      two largest producers and consumers of ethanol.
According to F.O. Licht, the size of global ethanol
output is about 10.2 billion gallons (36.7 billion    As public policy has generated tariffs, it has also
liters). Annual growth in output is projected at      opened a window in the tariff barrier. Since the
5-10% annually until 2012 when the fuel ethanol       late 1980s, the Caribbean Basin Initiative (CBI-
production could reach 17.2 billion gallons. The      a trade agreement between 22 Caribbean and
Kyoto Protocol has built a global constituency for    Central American nations and the United States)
ethanol production and use.                           has allowed ethanol which is manufactured and
                                                      dehydrated from indigenous feedstocks in those
The Fundamentals Driving the Ethanol Market           nations to enter the United States duty free. In
                                                      addition, a limited amount of ethanol that
In order to trade ethanol or any other commodity in
                                                      originates in other countries (non-indigenous
the physical or futures markets, participants need
                                                      feedstocks) but is dehydrated in the CBI countries
a basic understanding of the factors that affect
                                                      can be imported under the CBI without the tariff
the balance of supply and demand and thereby
                                                      (up to 7% of the previous year’s production by
influence pricing. There are three fundamental
                                                      U.S. plants).
areas that drive ethanol pricing:
Although the effect of government regulation            the ethanol production as an alternative use for
historically has been a negative factor in the market   their food products. Using sugar cane, Brazil
place, the pressure of regulatory incentives and        produces about 59% of the world supply of
mandates (derived from environment concerns)            ethanol.
on both supply and demand could have a net
positive effect on the ethanol industry in its          In the U.S. (the other leading ethanol producer),
transition from ad hoc to mature market.                corn farmers are eager to develop larger markets
                                                        for their ethanol production and the regulatory
Advances in Technology: the scientific debate over       climate currently supports these initiatives. North
ethanol as a desirable oxygenate and renewable          America (grain-based) produces about 38% of the
fuel source has heavily influenced public policy         world supply of ethanol.
decisions, as has the debate over global warming.
The science for creating ethanol has been around        In the European Union, positive movement on
a long time. Technology has responded initially         the legislative front has resulted in new tax laws
on the consumption end, designing and building          that have energized the biofuels industry. Ethanol
a wider range of vehicles that can use alternative      production from wheat, barley and sugar beet
fuels. The solvent characteristics of ethanol pose      molasses has been encouraged. France, Spain and
technological challenges in its transportation and      Sweden are now supporting ethanol production
storage. The technology exists to transport and         and consumption.
store ethanol successfully, but the cost remains
                                                        In the larger developing countries of Asia, such
high. The next challenge for technology will be
                                                        as China, India, the Philippines and Thailand,
to reduce this cost and help to streamline the
                                                        increasing industrial development, urban
distribution process.
                                                        pollution and population density problems,
Ethanol is primarily shipped by rail, by barge and      coupled with the rising costs of fuel imports
for international trade by tanker. There are many       are driving demand. Australia has also supplied
opportunities for the ethanol to pick up water or       tax incentives and direct support to encourage
leech other contaminants from pipelines or storage      production and use. Europe and Asia produce
containers. The possibility of water contamination      about 3% of the world’s ethanol from other
increases as the distance and time of travel and/       sources (beet molasses and grain).
or storage increases. This places a burden on the
                                                        Canada has announced a policy of ethanol support
transportation and storage system. For example,
                                                        with an objective of bringing 35% of the gasoline
water must be completely absent from ethanol
                                                        used in the country to a 10% ethanol blend by
(anhydrous ethanol) for blending with gasoline.
                                                        2010, compared to a 7% blend now.
And gasoline blending represents ethanol’s major
growth area.                                            Because of the hybrid nature of ethanol as a
                                                        commodity (part agricultural commodity, part
The Feedstocks: As the ethanol industry matures,
                                                        energy commodity), risk managers and investors
it is still dependent on the supply and demand
                                                        must track pricing factors in both sectors.
situation for its primary feedstocks (sugar and
grains). Brazil, the world’s largest sugar producer,    The price of sugar on the world market is a
furnishes 50% of the world’s sugar. Brazil and other    key variable in the Brazilian ethanol industry.
sugar-producing nations are eager to encourage          If sugar prices are high, sugar producers tend
                         World Fuel Ethanol Trade (BLN gallons)

SUPPLY                     2003                     2005                      2010
Brazil                     3.8                      4.2                       5.6
USA                        2.8                      3.5                       5.0
EU                         0.5                      1.0                       1.9
Other                      0.2                      0.9                       3.4
Total                      7.3                      9.6                       15.9


DEMAND                     2003                     2005                      2010
Brazil                     3.4                      3.7                       4.6
USA                        2.8                      3.5                       5.0
Canada                     0.1                      0.2                       0.4
EU                         0.4                      1.3                       3.4
Japan                      0.2                      0.5                       1.9
Other                      0.4                      0.4                       0.6
Total                      7.3                      9.6                       15.9


        *Projections based on a culmination of studies made by industry associations & consultants




                                 Percentage of Brazilian Sugar Cane
                                      Used for Ethanol/Sugar
to route more sugar cane to raw sugar and cut           its willingness and ability to adapt after so
back on ethanol production. In early 2004, the          many decades of “waiting in the energy line”
oversupply and lower price of world sugar led           to finally assume its place in the energy market,
to a lower price for world ethanol (around 60           but political realities will weigh heavily in the
cents/gal.) Conversely, a higher price for corn         debate as regulatory policy in relation to the price
and increased fuel consumption put pressure on          of gasoline at the pump once again becomes a
domestic ethanol production and helped to push          sensitive political issue.
domestic corn-based ethanol over $1.50/gal. In
that pricing scenario, even if one adds the 54          Disconnecting sugar and grain prices to some
cent tariff to the cane-based ethanol from Brazil,      degree from the availability of these commodities
obviously the price becomes more competitive.           for ethanol production is a necessary part of the
                                                        evolution of a reliable marketing chain. The
The relative cost of production for cane-based          ethanol industry may develop its own reliable
ethanol and corn-based ethanol offer competitive        supply lines with pricing less dependent on the
advantages and disadvantages. Corn requires             supply/demand for feedstocks.
significant amounts of energy in the operation of
heavy harvesting machinery (gasoline and diesel         The convergence of all the competing factors
fuel). Corn also requires large amounts of nitrogen     (regulatory,    social,    environmental,      and
fertilizer that uses natural gas in its manufacturing   economic) creates the historic conditions for
process. Sugar cane does not have the same energy       price risk exposure and the need for reliable tools
requirements but it demands large amounts of            to discover, manage and disseminate price – the
land/water and low-cost labor. Concerns over            exchange futures and options markets. Some of
deforestation and other environmental factors can       these same factors brought sugar into the Coffee
also affect sugar cane production.                      Exchange of New York in 1914 when World War
                                                        I threw the world sugar market into chaos. And
The price and availability of fossil fuels affects not  now a direct derivative of sugar – ethanol – turns
only feedstock production but the transportation        to that same proven mechanism to bring order to
and end-use of ethanol. Concerns that enormous          an increasingly frenetic marketplace.
demands for new ethanol production (with
California accounting for a third of all existing
production) would add 20 to 30 cents to the
price of gasoline generated a
political/economic debate.            Sa mple Volatility Comparisons 30-Day Volatility, 2003
Supply/demand pressures
in the oil industry have               Commodity            High      Low         Mean
created their own upward               U.S. Ethanol         24.6      6.8         12.9
price pressures apart from             Brazilian Ethanol    29.3      9.1         16.7
ethanol, so determining the
                                       Sugar                39.5      22.8        31.3
pricing effect of ethanol on
unleaded gasoline has proven           Corn                 28.6      11.4        29.1
to be difficult. The ethanol            Gasoline             70.5      33.3        46.3
industry has demonstrated
Ethanol Futures and Options                                    Price volatility, price risk, multiple buyers
                                                               and sellers, a quantifiable commodity with
Historically, the futures World Sugar No. 11                   standardized characteristics, reliable spot market
market has produced NYBOT’s largest total                      price history are some of the features necessary
annual volumes. In 2003, for example, total sugar              to build a futures and options market. The price
futures and options accounted for more than                    volatility and price risk are apparent in volatility
36% of all the contracts traded on the NYBOT                   and spot price statistics for ethanol.
exchanges. In the first quarter of 2004, the NYBOT
world sugar established impressive new all-time                The price of ethanol has declined on the world
daily and monthly total volume records.                        market and stabilized on the domestic front. Real-
                                                               time and delayed (30-min.) ethanol futures and
The global importance of the sugar trade                       option prices can be found at www.nybot.com.
provides a critical basis for the establishment of
the ethanol futures market. The size of the new                With so many variables at work in the pricing
ethanol contract (7,750 gallons) represents a                  of ethanol, the presence of a price benchmark
close approximation of the amount of ethanol                   is critical to the growth and economic stability
that can be produced from 112,000 pounds of                    of the ethanol industry. The New York Board of
raw sugar (the size of the Sugar No. 11 futures                Trade has created a world ethanol futures and
contract). The ethanol (anhydrous, undenatured                 options marketplace to bring some order to this
alcohol) deliverable against the contract does not             unpredictable pricing picture.
specify sugar-based ethanol. The contract treats
                                                               The ethanol futures contract calls for Free-on-
all ethanol as ethanol and makes no distinction,
                                                               Board (FOB) vessel delivery of bulk liquid ethanol
very much in the same way that the world Sugar
                                                               from any one of 9 countries of origin. The price
No. 11 contract makes no distinction between
                                                               is quoted in cents/gallon with a minimum price
sugar produced from beets or cane.
                                                               fluctuation of one/tenth cent/gal. (equivalent
                                                               of $7.75 per contract). Contracts are listed for




                                Brazilian Ethanol vs. NY Ethanol
                   200


                   180


                   160


                   140


                   120


                   100


                    80


                    60


                    40




                                    BRAZILIAN - Ethanol   NEW YORK - Ethanol
February, April, June, September and November. The ethanol must be biomass-derived, undenatured,
anhydrous ethanol at 60 degrees Fahrenheit. Regular options are listed for each contract month. Option
strike prices will be listed in five cent increments. Complete contract specifications can be found at www.
nybot.com.

A growing industry faces a growing price risk and the NYBOT ethanol futures and options market can
serve all levels of the marketing chain in a number of ways. Any of the following market participants,
exposed to price risk, could utilize the futures and options market:

        Ethanol producers; ethanol processors and dehydrating plants; energy trading companies;
        ethanol merchandisers; oil refiners, gasoline blending and marketing firms; sugar producers
        that produce ethanol; and chemical firms that produce synthetic ethanol.

With such a large number of fundamental factors influencing pricing for ethanol, the presence of a price
auction is critical. The Exchange represents a regulated and orderly marketplace in which price is the
primary commodity being bought and sold. Buyers and Sellers with price risk come together with equal
access to the market to negotiate the best price and they are joined by speculators/investors that trade from
both the buy and sell side and add important liquidity to the price discovery process.



The following examples demonstrate some basic hedging scenarios and strategies:

Long Futures Hedge
Scenario: A California refiner is physically short ethanol (needs to buy) for May gasoline production
requirements. The refiner has determined that the world price for ethanol is cheap relative to domestically
sourced ethanol. He decides to lock in the prices on a portion of his portfolio using NYBOT ethanol
futures. When he is able to source the physical supply he requires, he liquidates his futures position.



Cash Market                                         Futures Market
• On 2/10, cash prices are 45 cents                 • 2/10 Buys 100 April - 45 cents

• 4/22 Cash prices are 50.5 Buys physical           • 4/22 Sells 100 April – 50.5 cents


• supply 775,000 gallons at 50.5 cents


L oss – $42,625 (775,000 x .055)                    Profit – $42,625 (7,750 x .055 x 100)
Result: The buyer will need to purchase his supplies at a higher price in the physical markets, but will
make a corresponding profit in futures with a net reduction in the price paid for the required ethanol.

 Using an EFP to price and hedge a physical ethanol deal.
Scenario: One January 15, a South American ethanol producer sells a cargo of ethanol to a US refiner for
forward delivery at the end of April. They agree to price the 100,000 barrel cargo (4,200,000 gallons or
541 futures contracts) at a floating price differential to NYBOT futures to account for freight and quality
differentials. They agree to transact this deal as an EFP. An EFP (Exchange for Physicals) referred to in the
Exchange rules as “Against Actuals” or “AA”, allows the buyer and seller to link the pricing of the contract
to a privately negotiated futures price, which is posted on the exchange and liquidates the futures hedge
established by both parties. The EFP gives buyers and sellers flexibility on when they choose to initiate
their hedges on NYBOT.



 Refiner’s Strategy
 The refiner has analyzed the market fundamentals and thinks that the market is moving higher. He
 fixes the price of his cargo purchase by buying April ethanol futures. When he takes delivery from the
 producer, they mutually decide to fix the EFP price at the prevailing market price. Through this EFP
 transaction, the refiner then liquidates his long futures position.



 Cash Market                                              Futures Market
 • On January 15, US refiner, enters into a physical
   deal to purchase 4,200,000 gallons of ethanol.
   Physical forward price for April is 60 cents.          • 1/15 refiner buys 541 April @ 60 cents


 • 4/28 Delivery is made and refiner/ producer             • 4/28 Refiner sells 541 April – 71.0 EFP
   decide to post an EFP at the prevailing price
   of 71 cents


 Loss – 461,202.50                                        Profit – 461,202.50
 Refiner Result: With futures profit balancing the loss from the price rise in the physical market. Refiner
 pays a net price for ethanol of 60 cents/gal.
P roduce r’s Strategy
After entering into the physical deal, the producer also views the market as bullish and does not want to
lock in his sales price immediately. He refrains from locking in his sales price until a short term supply
interruption in March causes a brief spike in the market when he sells futures.



Cash Market                                             F utures Market
• On January 15, Producer enters into Physical
  deal to sell ethanol to a US Refiner on a
  differential to NYBOT. Price is 60 cents.            • On March 4, producer sells futures at 75 Cents.


• On April 28, Producer delivers product
  And fixes the EFP price with the buyer
                                                       • On April 28, Producer buys 541 April Futures
  At the prevailing futures price of 71
                                                         71 on an EFP.


Profit – 461,202.50                                 Profit – 167,710.00
Producer result: Adding the profit from th efutures hedge, the producer receives a net price of 75 cents./
gal for the delivery month.

Overall Comment: The flexibility of the EFP allowed buyer and seller to pursue independent hedging
strategies while affording the ease of liquidating the futures hedge with a futures transaction price
negotiated by buyer and seller, posted to the Exchange which liquidated the futures hedge positions. The
EFP is the only transaction which allows an off-exchange floor negotiation of price and must be linked to
a physical transaction. The Exchange may audit the transaction to assure the existence of a corresponding
physical transaction.
Using Options
Producer hedging with a put option to hedge unsold inventories
ABC Alcohol Co. has been maintaining ethanol inventory in a choppy and uncertain market for world
ethanol. As they look to find end use buyers for this inventory they are nervous about declining prices.
Yet, several market factors could potentially rally the market. They decide that the best strategy is to
buy puts at a strike price just under the cost of their production. They are willing to risk the loss of the
premium to protect against a sharp move to the downside, while maintaining access to the benefits of a
potential move to the upside. ABC has decided that they would like to get protection in case of a drop
below 50 cents and decide to purchase 200 August 50.0 puts.



Scenario 1: Prices continue to trade sideways in a choppy sideways market.
Cash Market                                        Futures/Options Market


                                                   • 6/15 August futures 57.5 cents
• 6/15 Cash Market is 57.5 cents
                                                   • 6/15 Buys 200 August 50.0 puts at 1.2 cents
                                                     for a one-time premium of $18600.

• 8/30 Cash Market is 59 cents                     • 8/30 Futures market is trading at 59 cents



Profit – 23,250                                      Loss 18,600


S cenario 2: Prices drop sharply.
Cash Market                                        Futures/Options Market
• 6/15 Cash Market is 57.5 cents                   • 6/15 August futures 57.5 cents


                                                   • 6/15 Buys 200 August 50.0 puts at 1.2 cents
                                                     for a one-time premium of $18600.

• 8/15 Cash market drops to 45 cents               • 8/15 Sells 200 August 50 puts at 5.1 cents
Scenario 3: Market rallies sharply.
Cash Market                                       Futures/Options Market

• 6/15 Cash Market is 57.5 cents                  • 6/15 August futures 57.5 cents

                                                  • 6/15 Buys 200 August 50.0 puts at 1.2
                                                    cents for a one-time premium of $18600.

• 8/15 Cash market rallies to 70 cents            • 8/15 200 August 50 puts expire worthless



Profit 193,750                                    Loss 18,600
Comment: In Scenario 1, the option expired worthless. Net loss to the company was the one time
option purchase price. In Scenario 2, the option put partially offsets the loss in the cash market. To
get more protection to the downside, ABC would have purchased a put with a higher strike price at a
higher premium. (Please note that on 8/15, the option is 5 cents in the money, but the company is able
to recover .1 cent in time value because it liquidates prior to option expiration). In Scenario 3, the
company has lost the one time premium but has been able to benefit by the market appreciation on its
cash position.

Conclusion

No one can predict the path the market will take, but the ethanol sector has its best chance to finally
step front and center and assume a key place, so long denied, at a unique intersection of the agricultural
and energy industries. The emerging picture of the ethanol industry is one of considerable potential
and NYBOT’s role as a provider of price discovery and risk transfer tools comes at a critical time for the
industry.
E
     thanol futures and options are offered through the traditional commodity markets of the New York Board of

     Trade. For more information, contact a licensed futures broker or visit the NYBOT web site at www.nybot.com.

For real time or delayed market data, visit www.nybotlive.com.




This brochure serves as an overview of the ethanol futures and options offered through the exchange markets of the

New York Board of Trade® (NYBOT®). Examples and descriptions are designed to foster a better understanding of the

ethanol futures and options market. The examples and descriptions are not intended to serve as investment advice

and cannot be basis for any claim. While every effort has been made to ensure accuracy of the content, the New York

Board of Trade does not guarantee its accuracy, or completeness or that any particular trading result can be achieved.

The New York Board of Trade cannot be liable for errors or omissions in the content of this brochure. Futures and

Options trading involves risk and is not suitable for everyone. Trading on the NYBOT is governed by specific rules

and regulations set forth by the exchange. These rules are subject to change. Contact a licensed broker for additional

information. For more detailed information and specifications on any of the products traded on the NYBOT markets,

contact NYBOT or your broker.
      The New York Board of Trade (NYBOT) is the parent company of the Coffee, Sugar & Cocoa Exchange,
      Inc. (CSCE) and the New York Cotton Exchange (NYCE®). Through its two historic exchanges, the NYBOT
      provides a global marketplace for a wide variety of traditional and innovative agricultural and financial
      products including futures and options for cocoa, coffee, cotton, ethanol, orange juice, sugar and curren-
      cies as well as equity, currency and commodity indexes.


      Beginning in 1870 with the founding of the original New York Cotton Exchange, the NYBOT exchang-
      es have built and sustained crucial futures and options markets through dangerous and difficult times.
      The exchanges of the New York Board of Trade have a long history of providing effective price discovery
      and risk management tools for major international industries. Risk management is the foundation of
      our business.


      The New York Clearing Corporation (NYCC) – the designated clearinghouse for all NYBOT markets – rep-
      resents over a century of continuous financial integrity.


      The New York Board of Trade® and NYBOT® are registered trademarks of the Board of Trade of the City
      of New York, Inc. Charts and other graphics have been provided courtesy of F.O. Licht and Hart Energy
      Publishing, LP.




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