Does Hedging Affect Commodity Prices? The Role of Producer Default Risk

Abstract

Do hedging and speculative activity in commodity futures affect spot prices? Yes, when commodity producers have hedging needs. We build a model in which producers are risk-averse to future cash flow variability and hedge using futures contracts. Increases in speculative demand for futures reduces the cost of hedging, allowing producers to hedge more and hold larger inventories. This pushes spot prices higher. Reductions in speculative demand for futures have the opposite effects. The data provide support for the hedging channel we identify - oil and gas producers - hedging demands (proxied by their default risk), forecast spot prices, futures prices and producers' inventories.