It’s January 1, 2004 and you run a small refinery that processed 1000 bbls of oi

Question

It’s January 1, 2004 and you run a small refinery that processed 1000 bbls of oil in 2003 and you expect your needs to grow 10% per year for the next 6 years.

You are nervous about supply of oil and so you are considering entering into a six year contract with a producer. You are given three options for contracts to acquire your forecast quantities:

You can purchase at the spot price.

You can purchase at the spot price - $2/bbl but there's a floor (minimum price you would pay) of $20

You can purchase at spot price + $1 but there's a floor of $21 and a cap (maximum price you would pay) of $28.

Which of these three options is the best? Which is the worst? Show a graph(s) and statistics to support your answers.

Hint : The spot price of oil is random ... you might want to use an oil price forecast for 2004-2009.

Explanation / Answer

Solution :

Supoosingly spot oil price is $60 per bbl

hence option 2 is better off & option 1 is worst

particulars option 1 option 2 option 3 purchase at spot rate purchase at spot -2 per bbl but min floor priceof $20 purchase at spot +1 but max cap $28 minimum outlay 60 20 21 maximum outlay 60 58 61 unavoidable outlay 60 38 40

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