What is a swap?
An airline needs jet fuel in 3, 9, and 15 months. Instead of guessing future prices, it agrees a fixed price today with a swap dealer.
At each settlement date, the market price is compared to the fixed price. If the market is higher, the airline receives the difference. If lower, it pays. Either way, the airline knows its effective cost upfront.
How is the fair fixed price found?
The fair fixed price is set so that the net present value (NPV) of the swap is zero at inception. Both legs must have equal value today.
Step 1 — Discounted cash flows (fixed leg): At each date t, the fixed payer pays Volume × Fixed price. In present value that is Vt × K × DFt, where DFt = 1/(1+rt×t) is the discount factor. Sum: Σ(Vt × K × DFt) = K × Σ(Vt × DFt).
Step 2 — Discounted cash flows (floating leg): The floating leg pays Volume × Futures price. Today's expected value of that future payment is Vt × Ft × DFt. Sum: Σ(Vt × Ft × DFt).
Step 3 — Set NPV = 0: K × Σ(Vt × DFt) = Σ(Vt × Ft × DFt), so:
Nearer dates have higher discount factors (DF closer to 1) and thus carry more weight. Higher volumes also increase a date's influence. Toggle "Show calculation details" in the calculator to see the numbers.
What happens at settlement?
Dealer receives: Volume times Fixed price (what was agreed).
Airline receives: Volume times Market price (what the fuel actually costs).
Net to airline: The difference. If market price is above fixed, airline gains. If below, airline pays. The chart on the right shows this flow.
Curve shape: up or down?
If future prices rise over time (3 mo cheaper, 15 mo dearer), the curve slopes up — this is contango. If they fall over time, it slopes down — backwardation. The fair fixed price sits somewhere in the middle of the curve.
Risk considerations: credit, collateral & margin
Counterparty (credit) risk: If the dealer or airline defaults, the other party may not receive owed payments. This is a key concern in bilateral (OTC) swaps.
Role of clearing houses: Many commodity swaps are cleared through central counterparties (CCPs), which become the buyer to every seller and the seller to every buyer, thereby eliminating bilateral counterparty risk.
Margin requirements: Under EMIR (EU) and CFTC rules, cleared commodity swaps require initial margin (posted at trade inception) and variation margin (daily mark‑to‑market settlement). Uncollateralised OTC swaps face capital charges and, where applicable, mandatory clearing.
Other commodity swap variants
The example above is a plain-vanilla jet fuel price swap. Other common types:
- Spread swaps — e.g. gas vs oil (spark spread), or Brent vs WTI; you exchange the differential, not the absolute price.
- Basis swaps — lock in the difference between two related prices (e.g. a regional hub vs a benchmark).
- Calendar swaps — exchange prices between two delivery periods (e.g. summer vs winter).
In many markets, swaps are quoted as differentials to futures (e.g. “TTF gas swap = ICE futures + 2¢”), which simplifies pricing and hedging against the futures curve.