Uranium producers can hedge against falling uranium price by taking up a position in the uranium futures market.
Uranium producers can employ what is known as a short hedge to lock in a future selling price for an ongoing production of uranium that is only ready for sale sometime in the future.
To implement the short hedge, uranium producers sell (short) enough uranium futures contracts in the futures market to cover the quantity of uranium to be produced.
An uranium mining company has just entered into a contract to sell 25,000 pounds of uranium, to be delivered in 3 months' time. The sale price is agreed by both parties to be based on the market price of uranium on the day of delivery. At the time of signing the agreement, spot price for uranium is USD 53.00/lb while the price of uranium futures for delivery in 3 months' time is USD 53.00/lb.
To lock in the selling price at USD 53.00/lb, the uranium mining company can enter a short position in an appropriate number of NYMEX Uranium futures contracts. With each NYMEX Uranium futures contract covering 250 pounds of uranium, the uranium mining company will be required to short 100 futures contracts.
The effect of putting in place the hedge should guarantee that the uranium mining company will be able to sell the 25,000 pounds of uranium at USD 53.00/lb for a total amount of USD 1,325,000. Let's see how this is achieved by looking at scenarios in which the price of uranium makes a significant move either upwards or downwards by delivery date.
As per the sales contract, the uranium mining company will have to sell the uranium at only USD 47.70/lb, resulting in a net sales proceeds of USD 1,192,500.
By delivery date, the uranium futures price will have converged with the uranium spot price and will be equal to USD 47.70/lb. As the short futures position was entered at USD 53.00/lb, it will have gained USD 53.00 - USD 47.70 = USD 5.3000 per pound. With 100 contracts covering a total of 25000 pounds, the total gain from the short futures position is USD 132,500
Together, the gain in the uranium futures market and the amount realised from the sales contract will total USD 132,500 + USD 1,192,500 = USD 1,325,000. This amount is equivalent to selling 25,000 pounds of uranium at USD 53.00/lb.
With the increase in uranium price to USD 58.30/lb, the uranium producer will be able to sell the 25,000 pounds of uranium for a higher net sales proceeds of USD 1,457,500.
However, as the short futures position was entered at a lower price of USD 53.00/lb, it will have lost USD 58.30 - USD 53.00 = USD 5.3000 per pound. With 100 contracts covering a total of 25,000 pounds of uranium, the total loss from the short futures position is USD 132,500.
In the end, the higher sales proceeds is offset by the loss in the uranium futures market, resulting in a net proceeds of USD 1,457,500 - USD 132,500 = USD 1,325,000. Again, this is the same amount that would be received by selling 25,000 pounds of uranium at USD 53.00/lb.
As can be seen from the above examples, the downside of the short hedge is that the uranium seller would have been better off without the hedge if the price of the commodity went up.
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