September 19, 2001
Financial Risk
Management in Action
110 William Street, 11th Floor
New York, NY 10038, U.S.
tel: +1 212 621 4900
fax: +1 212 621 4949
www.chemweek.com
An aromatics case study
C
ommodity petrochemical companies may not be able to predict forward product
pricing, but they can use tools like futures to reduce the impact of price fluctua-
tions on bottom-line performance. Some leading companies—including Dow
Chemical and Shell Chemicals—are already using financial derivatives to reduce risk
and improve margins, but for others the first step is to see these powerful and complex
tools in action. No doubt there is a
learning curve associated with sophisti-
cated products like futures, but the
potential reward—improved margins
and profits—is hard to ignore.
In the following case study, Clif Cur-
rin of online chemical exchange
CheMatch.com shows
how a mixed xylenes
manager at Aromatics
Chemical Company, a
fictional aromatics pro-
ducer subject to real-
world prices and mar-
ket dynamics, uses
Clif Currin futures to reduce the
company’s financial risk from Decem-
ber 2000 to June 2001. The net results
are more stable margins, stronger prof-
its and improved shareholder value.
Background
Pete is the manager of the mixed
xylene business for the Aromatics
Chemical Company. The compa-
ny operates a Mobil Selective
Toluene DisProportionation
(MSTDP) unit, which uses
100,000 barrels/month of toluene
to produce mixed xylenes and
benzene. During the first eleven
months of 2000, the business
environment was poor and the
MSTDP operation did not fully
24-25 Scala Street recover cash costs. But early in
London W1T 2HP U.K.
tel: +44 20 7436 7676
December, the markets were
fax: +44 20 7436 3749 looking better. Pete’s analysis of
Complex processes,
complicated markets
The commodity petrochemical industry’s complex
production base—with many processes generating a
number of products and by-products—makes it par-
ticularly difficult for companies to match supply and
demand while also meeting price and profitability
targets.
Both Aromatics Chemical Company and Pete’s
mixed xylenes business are subject to the unique
constraints of aromatics production and markets. It
takes 2.2 gallons of toluene as feedstock to make
one gallon of mixed xylene and one gallon of ben-
zene. While each of these chemicals have relation-
ships to each other, they also have their own supply
and demand fundamentals.
Like others in this complex industry, Pete is both a
consumer and producer of petrochemicals. As such,
market fundamentals that may be beneficial to one
of the chemicals he uses or produces may also have
a negative impact on other chemicals involved in his
business.
More specifically, Pete is a consumer of toluene, a
high-octane component in gasoline that tracks the
gasoline market. Toluene prices increase when gaso-
line demand is high and octane is in short supply.
Pete is a producer of mixed xylene, which is used
to make paraxylene, a raw material for polyester
resins and fibers. These in turn are used to make
beverage bottles, apparel, carpet, and many other
common household products.
Pete’s business also produces benzene, a co-
product of mixed xylene production, which is pri-
marily used in the production of styrene. Styrene is
used to make polystyrene, which ends up in packag-
ing, housewares, furniture, appliance parts and elec-
trical components. Benzene has many other uses as
well, including cyclohexane for nylon production.
Because each of these chemicals responds to its
own supply and demand fundamentals, Pete is
exposed to volatile margins. Unfortunately, this led
to many sleepless nights for Pete.
 Special Advertising Section
Figure 1
the fundamental supply/demand projections indicated that Historical Margin of Producing Xylene
mixed xylenes would be strong in the first six months of 2001. and Benzene from Toluene via MSTDP
Even so, Pete was concerned about his inability to project 0.40
profitability.
0.30
The Risk
In December, as Pete assessed the coming year, his margins
0.20
looked to be about average, based on physical market prices

Variable Margin, $/gal of Xylene

and variable margins throughout 2000 (Figure 1). He expected
0.10
2001 to be a stronger year for mixed xylenes because invento-
ries were low and demand for polyethylene terephthalate
0.00
(PET) was growing despite the weakening economy. Although
the toluene price was an unknown, Pete expected demand to
-0.10
increase with the beginning of the gasoline production season.
Pete was concerned, however, about the outlook for one of his
products. Benzene demand was falling and along with that, its -0.20

price. His research suggested that demand in Asia/Pacific was

slowing and both benzene and styrene inventories would rise. -0.30 Jan-00 Feb-00 Mar-00 Apr-00 May-00 Jun-00 Jul-00 Aug-00 Sep-00 Oct-00 Nov-00

So despite good mixed xylene fundamentals, his margin was at

risk. Pete was looking for a way to manage some of these
unknowns and hedge his margin, not to mention get a better Figure 2
night’s sleep.
Benzene and Gasoline Forward Curve
The Evaluation 1.50
The first thing Pete did was look at the options available for get-
1.40
ting some kind of certainty regarding his toluene costs In 1.40
1.36
November, toluene was trading at $0.15/gal above unleaded 1.30
1.35
1.33 1.33
1.30
gasoline, which was slightly lower than 1999’s average of 1.26
$0.16/gal. To check his opportunities for forward pricing, Pete 1.20 CME/CheMatch Benzine Futures Strip on 12/5/00

logged on to CheMatch.com and found an offer to sell 30,000

1.10
Price, $/gal

barrels/month of toluene at the price of unleaded gasoline plus

$0.19/gal for 12 months, beginning January 2001. Although the 1.00
$0.19/gal differential was expensive relative to the prior year,
Pete thought he could work with that price if he could also lock 0.90
Unleaded Gases Futures Strip on 12/5/00
in an attractive forward price for benzene or xylene. 0.80 0.83 0.82 0.81
Pete then looked at the forward prices of the CME-Chematch 0.77 0.78
0.80
0.76
Benzene futures contract, which was trading on Chicago Mer- 0.70
cantile Exchange’s GLOBEX2 electronic matching engine. He
0.60
accessed the information directly from CheMatch.com and com- Jan-01 Feb-01 Mar-01 Apr-01 May-01 Jun-01 Jul-01

pared that to future unleaded gasoline prices (Figure 2). As the

chart shows, the markets believed benzene would weaken rela-
tive to unleaded gasoline. The spread in the nearby month, Jan- Figure 3
uary, was $0.64/gal and gradually dropped in the other months
to a more historic norm of $0.46/gal. This was in line with Pete’s Projected MSTDP Margin
opinion but he wondered whether locking in these prices would 0.40
secure an acceptable margin. To accurately project a margin, he
would also need a forward mixed xylene price, which he did not 0.30
have. So Pete decided to run a scenario to see one possible out-
come. 0.20
First Pete calculated what his toluene price would be if he
Variable Margin, $/gal of Xylene

bought the $0.19/gal differential to unleaded gasoline and 0.10

locked in his price based on the forward curve in Figure 2. He
then used the CME-Chematch forward benzene strip for his
0.00
benzene pricing. Finally, he assumed the mixed xylene price
would remain at the current level. The results of Pete’s work are
-0.10
shown in Figure 3. Historical
Projected
The margin under this scenario looked good for the first four
months of the year and better than average for the next two -0.20

months. Pete knew, however, that he had made the assumption

that mixed xylene pricing would remain constant. But since that -0.30 Jan-00 Mar-00 May-00 Jul-00 Sep-00 Nov-00 Jan-01 Mar-01 May-01

was highly unlikely, he decided to examine that assumption.

c2 A CH EM IC AL WEEK ASSOCIATES Custom Publication September 19, 2001 www.chemweek.com

 Special Advertising Section
Figure 4
Over the previous year, the mixed xylene contract
Aromatics Dynamics price to toluene spot price differential averaged
-$0.02/gal. The mixed xylene Pete produced actually
1.1 gal Toluene 1 gal Benzene commanded a premium, however, because of the puri-
MSTDP ty of its paraxylene component. The relationship of his
Process 1 gal Mixed Xylene
mixed xylene value and the contract price had still
1.1 gal Toluene
been fairly stable, though, and he felt the basis risk
was minimal. The current differential of toluene to
mixed xylene was close to the average at -$0.03/gal.
Table 1 Based on history, the chances of the mixed xylene
price falling or rising relative to toluene were roughly
Toluene, Benzene Pricing the same. However Pete’s research into the funda-
Toluene Benzene mental supply and demand balance suggested that
Purchase Price Sale Price
($/gal) ($/gal) mixed xylene would be stronger than toluene. In that
Jan-01 0.95 1.40 case, the price difference would improve his margin.
Feb-01 0.96 1.36 With that in mind, he formed a strategy.
Mar-01 0.97 1.33
Apr-01
May-01
1.02
1.01
1.36
1.33
The Strategy
Jun-01 1.00 1.30 Pete decided to split his margin risk into two compo-
nents, as shown in Figure 4. First, he was at risk for
the price spread of benzene to toluene. If the price spread fell, his margin would decline. Based on his analy-
sis of the fundamentals and the forward pricing available he decided to hedge this risk.
His second risk was that the mixed xylene to toluene price spread would fall, which would also reduce his
margin. Since he believed that mixed xylenes values would increase relative to toluene, he wanted that part of
his margin to remain exposed to the market. Because of this strategy, he knew his total margin might be larg-
er or smaller than the projected margin in Figure 3, because he was still exposed to some toluene and mixed
xylene price risk.
His strategy, then, was to lock in a forward price for his actual purchases of toluene, and to hedge his ben-
zene prices with futures contracts.

Execution
In the afternoon, Pete again went to the CheMatch.com exchange and negotiated against the toluene posting
priced at unleaded gasoline plus $0.19/gal. He countered with a six-month term beginning January 2001 for
50,000 barrels/month at the offered price differential of $0.19/gal. He also requested locking in the toluene price
for all months based on the corresponding month closing price for unleaded gasoline futures for 12/5/00 (Figure
2). His counter offer was accepted by a toluene producer Pete had done considerable business with in the past.
Still on CheMatch, Pete accessed the Chicago Mercantile Exchange and hedged his benzene price by selling
46 CME-CheMatch Benzene futures contracts (46,000 barrels/month, the amount of benzene made from
50,000 barrels of toluene) in each of the first six months of 2001. Table 1 shows the prices Pete locked in.
If, as Pete thought, benzene prices did fall, he could offset (buy back) his benzene futures contract for less than
he sold them for, and use the profit from that transaction to help compensate for the lower cash benzene price.

Results
Pete’s market assessments proved to be correct. In
January the physical (cash market) benzene contract
settled at $1.37/gal, so when Pete offset his January
CME-CheMatch Benzene futures contract he paid
$1.37/gal versus his previous Jan. 01 sale at
$1.40/gal (Table 1), netting him a financial gain of
$0.03/gal. In the physical market he sold benzene at
the $1.37/gal contract price, but when he added his
financial gain of $0.03/gal from his futures hedge, his
effective price was $1.40/gal, just as he planned. He
calculated his margin using the $1.40/gal benzene
price and the $0.95/gal price he locked in for toluene
in January, and calculated a margin of almost
$0.21/gal of mixed xylene.
How much had the futures hedge helped? Pete
recalculated the margin had he not hedged. The physi-
cal benzene price was $1.37/gal and the spot toluene
physical price was $1.08/gal. Using these prices he

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 Special Advertising Section
Figure 5
determined that the operation would
Actual Hedge Performance have made only $0.03/gal on mixed
xylene. Hedging the January ben-
0.60
zene to toluene spread represented
0.50 approximately $350,000 of benefit
(($0.21/gal-$.03/gal) x 42 gal/bbl x
0.40
46,000 barrels/month)—a successful
0.30 hedge indeed.
As the months progressed, Pete

Variable Margin, $/gal of Xylene

0.20
continued to track his strategy’s per-
0.10 formance. Figure 5 shows the results
0.00
of his plan. The strategy to lock in the
benzene to toluene differential using
-0.10 futures and physical forwards met his
-0.20 objective and significantly improved
his profitability. The strategy to hedge
-0.30 Historical
As Hedged the six months improved his prof-
No Hedge
-0.40 itability by over $3.3 million. Pete
wanted to summarize how each “leg”
-0.50 Jan-00 Mar-00 May-00 Jul-00 Sep-00 Nov-00 Jan-01 Mar-01 May-01 of the hedge contributed to overall
performance, and developed Table 2.
Table 2
Hedge Components, Results
Toluene Toluene Conversion Toluene Benzene Benzene Benzene Total
Hedge Hedge to Xylene Hedge Futures Contract Hedge Hedge
Price Price Basis Advanatage Price Price Advantage Benefit
($/gal of toluene) ($/gal of toluene) ($/gal of xylene) ($/gal of xylene) ($/gal of xylene) ($/gal of xylene) ($/gal of xylene)
Jan-01 $0.95 $1.09 x 1.1 = $0.15 $1.40 $1.37 $0.03 $0.18
Feb-01 $0.96 $1.10 x 1.1 = $0.15 $1.35 $1.40 -$0.05 $0.10
Mar-01 $0.97 $1.08 x 1.1 = $0.13 $1.33 $1.15 $0.18 $0.31
Apr-01 $1.02 $1.23 x 1.1 = $0.23 $1.36 $1.10 $0.26 $0.49
May-01 $1.01 $1.22 x 1.1 = $0.23 $1.33 $1.17 $0.16 $0.39
Jun-01 $1.00 $0.95 x 1.1 = -$0.05 $1.30 $1.13 $0.17 $0.11

Pete had also clearly benefited from buying toluene at the hedge price instead of market
price. In January this was a $0.14/gal advantage. Since Pete hedged 1.1 gallon of toluene
for each gallon of mixed xylene, he converted his figures so he could compare the costs on
a gallon-to-gallon basis. ($0.14 x 1.1 = $0.15). The benzene contribution was based on the
advantage of selling benzene at the futures price in December instead of the monthly
physical contract price. No conversion factor was needed as he hedged one gallon of ben-
zene for each gallon of mixed xylene.
Different aspects of his strategy came into play at different times. The toluene leg,
which protected him from rising feedstock costs, was the most significant factor in Janu-
ary and February. While the benzene leg protected him from a lower sale price in Janu-
ary, he gave up some opportunity in February as the benzene market rose. He was satis-
fied, though, as his risk profile was much lower. In March and April the benzene leg was
the major contributor to his hedge. It protected him from the dramatic fall in the benzene
contract price that was the result of lower demand and high inventories, which was pre-
cisely what he was concerned about in December when he formed this strategy.
By assessing his needs, understanding relevant market fundamentals, and using the risk
management tools available to him, Pete was able to significantly impact his bottom line.
—By Clif Currin, Vice President,
Over-the-Counter Products and Derivatives, CheMatch.com

All historical data provided by DeWitt & Company Inc.; MSTDP economic model by Chemical Data Inc.;
All figures and tables by CheMatch.com.

If this article has raised questions you’d like answered, please don’t hesitate to contact:
Clif Currin Chicago Mercantile
CheMatch.com Exchange Inc. CheMatch.com
tel: 1-713-681-8140 www.cme.com www.chematch.com
cbcurrin@chematch.com email: info@cme.com tel: 1-888-525-1000

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