2011-02: A Note on the Presence of Inconvenience Yields in Bulk Commodity Markets (Working paper)

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West, Jason
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Akimov, Alexandr

Date
2011
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19 pages

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Abstract

The presence of a st rong contango in the term structure for thermal coal implies a h ighly negative convenience yield. This paper examines the conditions that lead to negative convenience yields for bulk commodities. We show that convenience yields for bulk commodities are dominated by the effect of oversupply rather than the combined effect of increases in inventory costs and decreases in the volatility of the underlying cash commodity. Producers clearly prefer to stockpile the commodity rather than adjust production in response to a contraction in demand. The data also reveals the inverse relationship between convenience yields and inventory levels is more significant when convenience yields are negative and deferred forward contracts are less volatile than near maturity contracts. We also demonstrate that the effect of convenience yield monotonically diminishes with maturity.

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Copyright © 2010 by author(s). No part of this paper may be reproduced in any form, or stored in a retrieval system, without prior permission of the author(s).

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Subject

Q41 - Energy: Demand and Supply

C53 - Forecasting Methods; Simulation Methods

Commodities

Convenience yield

Forward markets.

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