Introduction

The commodity derivatives market has strongly increased in recent years, both in trading volume and the variety of offered products. Adequate models to price and hedge commodity futures and options are required and a multitude of models are already proposed. However, the derivative pricing theory developed for financial assets cannot be utilized for commodity derivatives without some adaptations, since it is important that the models capture the empirical properties of commodity price processes. The most important among these are mean reversion in spot and futures prices and backwardation in futures prices for some commodities.1 Backwardation is an implication of mean reversion and may be used as a predictor for mean-reverting spot prices.2 Unlike financial assets, supply and demand for commodities are to a large extent influenced by production costs and consumer behavior. When prices are low, consumption will increase and high-cost producers will leave the market. This leads to an increase in prices. When prices are relatively high, consumers and producers will react vice versa, putting a downward pressure on prices.3 Additionally, the level of inventories plays an important role in determining the value for storable goods.4 The owner of the good decides whether to consume it immediately or store it for future disposal. Hence, the price of the commodity is the maximum of its current consumption and asset values.5