The Role of Derivatives In Managing Risk In Petroleum Industry: Case Study of Nigerian Petroleum Industry

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Contents

Working Title3

Background3

Introduction and Rationale3

Purpose of the Study4

Significance of the Study5

Research Aim and Objectives6

Reserach Question6

Literature Review7

Industry Background7

Research Methodology8

Research Design8

Research Philosophy10

Research Instrument14

Case Study Analysis15

Consideration of Rigour16

Consideration of Ethics16

Time Scale16

Gantt chart (Sept 2012 - Nov 2012)16

Resources17

Proposed budget and resources17

References18

Working Title

The role of derivatives in managing risk in Petroleum Industry: Case Study of Nigerian Petroleum Industry

Background

Introduction and Rationale

Derivatives are complex financial instruments that derive their value from another underlying asset; however, it does not represent any ownership rights in the asset. This asset can be in the form of commodities, stocks, contracts, and any other financial security. Financial derivatives have emerged to become effective tools to hedge against risk and limit the exposure to any major losses (Joseph, 2000). Historically, the idea of agreeing a sale to materialize at a time back stems from trading. In the seventeenth century, in Holland derivatives contracts were traded whose assets were bulbs tulips. In Japan, there came the first organized market to negotiate contracts on the future delivery of rice (underlying asset). Knowing which would be the price received or paid by a crop, it enabled both the producer and buyer faced the future with greater confidence. In the nineteenth century, Chicago's first modern derivatives market was founded, where contracts are traded on commodities (maize). Subsequently, the First Financial derivatives on exchange rates were created in 1973. Afterwards, derivatives markets were created in major global financial markets (Chicago, London, New York, Frankfurt), where trading was done of commodity derivatives trading (commodities) against financial assets (Exchange rates) (Braddock, 1997).

Derivatives have introduced a new regime in the financial market era. The history of derivatives goes back to 1800 in America, when it was mainly used for trading agriculture commodities. In modern times, the same derivations have proved to be crucial component of global interest rate markets. However, their application in the energy industries is relatively new generally in global world while in US particularly (Macaskill, 2005). They received a major boost after the deregulation of the energy prices within the petroleum industries which revealed that prices of petroleum and other energy products are more volatile than any other product / commodity so far. In order to protect themselves against price fluctuations, consumers sought ways to hedge their exposure which can allow them to incur millions of losses within a very short time. As a result, the awareness and use of derivatives witnessed a significant increase in this sector (Sundaram & Das, 2010).

The fundamental purpose of derivative contracts are to transfer risk, most commonly, price risk, to those parties who are in better position and willing to bear this risk against a premium amount (Hull, 1997). In derivatives, this premium amount refers to the compensatory fee for bearing the transferred risk (Braddock, 1997). However, the applications of derivatives are not restricted to risk transference. As a matter of fact, if we view from investor's point of view, they are source of earning incomes based on ...