Oil, natural gas, copper, and gold are traded in markets that span physical producers, refiners, utilities, trading houses, hedge funds, and banks. The derivatives that price and hedge these commodities are directly connected to the underlying physical market in a way that equity or rate derivatives are not — the price of a WTI futures contract is ultimately anchored to actual barrels of crude oil available at Cushing, Oklahoma.
Futures vs Forwards in Commodities
The two principal instruments for commodity price risk management are futures and forwards. Both lock in a price for a commodity at a future date, but they differ structurally:
Futures are exchange-traded, standardised contracts. They are marked to market daily with variation margin passing through a central counterparty (CME for WTI and gold; ICE for Brent). Standard lot sizes (1,000 barrels for WTI), standard delivery months, and standard quality grades remove all ambiguity. The vast majority of futures positions are closed before delivery — participants roll to the next contract rather than taking physical delivery.
Forwards are OTC contracts negotiated bilaterally. They specify delivery of a precise quantity, quality, location, and date. A refinery buying North Sea crude from a producer will use a forward specifying exactly what cargo arrives at which port on which date. Forwards are used where standardisation doesn't fit the physical transaction.
Physical vs Financial Settlement
Commodity derivatives can settle either physically (the commodity actually changes hands) or financially (a cash payment based on the price difference). For exchange-traded futures, most market participants — hedge funds, banks, financial intermediaries — will roll or close their positions before the delivery window to avoid physical settlement. The minority that do take delivery must meet strict quality and logistics specifications.
Financial settlement uses a published price index — for example, Platts Dated Brent for North Sea crude, or the ICE NBP index for natural gas — as the reference price. Many OTC commodity swaps settle financially: a refinery buys a fixed-price swap on jet fuel, and at expiry the bank pays the difference between the fixed price and the realised spot average, in cash.
WTI and Brent Crude Oil
WTI (West Texas Intermediate) and Brent are the two global crude oil benchmarks. WTI is a light, sweet crude delivered at Cushing, Oklahoma. It is the benchmark for US crude production and the NYMEX futures contract. Brent is a blend of North Sea crude streams (Brent, Forties, Oseberg, Ekofisk — the BFOE basket) and is the global reference price for two-thirds of the world's oil trades.
The price spread between Brent and WTI (the Brent/WTI differential) fluctuates based on transport costs, US export constraints, and production dynamics. At times, Brent trades at a premium to WTI; at others (when US production surges and pipeline capacity to the coast is constrained), WTI can trade at a significant discount. This differential is itself actively traded.
The April 2020 WTI futures episode is a landmark event: on 20 April 2020, the front-month WTI futures contract fell to minus $37.63 per barrel — the first time in history that an oil futures contract went negative. The cause was a combination of COVID-19 demand destruction, storage at Cushing filling to capacity, and the mechanics of futures delivery: holders of near-expiry contracts who could not take physical delivery had to pay others to take it from them.
Natural Gas
Natural gas markets are regional, not global, because gas is expensive to transport (it requires liquefaction into LNG for shipping). UK gas trades at the National Balancing Point (NBP); US gas at Henry Hub (Louisiana); European gas at the TTF hub in the Netherlands. Gas prices are highly seasonal — demand spikes in winter for heating — and extremely sensitive to supply disruptions, as Europe discovered in 2022 when Russian pipeline flows were curtailed.
Gas derivatives include NBP/TTF/Henry Hub futures and OTC swaps, options on gas prices, and physical forward contracts. Storage plays a critical role: gas is injected into storage in summer (when demand is low and prices typically lower) and withdrawn in winter. The shape of the gas forward curve — the price across different delivery months — reflects expectations about seasonal demand and storage availability.
Contango and Backwardation
Contango is when futures prices for later delivery months are higher than the spot price. This is the normal condition when storage costs are positive: if you can buy oil today and sell it forward for more, you would do so until the forward premium equals the cost of storage, insurance, and financing. Contango is a headwind for commodity index investors, who must roll expiring contracts into higher-priced next-month contracts — selling cheap, buying expensive.
Backwardation is the reverse: spot prices exceed futures prices. This occurs when physical demand is acute and immediate — buyers will pay a premium for immediate delivery. Backwardation rewards long investors who roll: they sell expiring contracts at a premium, buy the cheaper next-month contract. Strong backwardation in the oil market typically signals tight physical supply.
Copper, Gold, and Base Metals
Copper is the industrial metal most sensitive to global economic growth — its demand comes from construction, electrical infrastructure, and electric vehicles. Copper trades primarily on the London Metal Exchange (LME), which has unique features: prompt dates run every business day (not just monthly); warehouses globally hold physical copper; and the LME price is the reference for the majority of global copper transactions.
Gold is a monetary metal and a safe-haven asset. The benchmark is the LBMA Gold Price (formerly the London Gold Fix), set twice daily. Gold is stored in allocated or unallocated form in vaults (mainly in London and New York). Unlike oil or copper, gold has almost no industrial consumption relative to its stock — virtually all gold ever mined still exists, which means supply/demand dynamics for gold differ fundamentally from other commodities.
Basis Risk
A refinery that buys crude oil and sells refined products (jet fuel, diesel, gasoline) faces basis risk: the risk that its hedging instrument does not perfectly match its physical exposure. If a UK airline hedges jet fuel exposure using Brent crude futures, it is exposed to the crack spread — the difference between the crude price and the jet fuel price. The crack spread is itself a derivative that can be traded, but it introduces another layer of basis between the standardised exchange product and the physical commodity being hedged.