Explanation

This question involves stack-and-roll hedging and roll yield concepts in commodity futures markets.

Key Information:

• Spot price: $106
• 1-month futures price: $102
• 12-month futures price: $98
• Market is in contango (futures prices are lower than spot price)
• Spot price remains unchanged at $106 throughout the year

Analysis:

1. Market Structure: The futures curve is in contango because:

   • Spot ($106) > 1-month futures ($102) > 12-month futures ($98)
   • This means longer-dated futures are trading at lower prices than shorter-dated ones

2. Roll Yield in Contango:

   • When the market is in contango, rolling futures positions forward typically results in negative roll yield
   • Each time the hedge is rolled, the producer must sell the expiring futures contract and buy a new one at a lower price
   • This creates losses as the futures position is "rolled down" the curve

3. Stack-and-Roll Hedge Performance:

   • The producer starts with futures contracts at $102 (1-month)
   • As contracts expire each month, they must be replaced with new contracts
   • Over the year, the futures position will gradually move from $102 down to $98
   • This creates a loss of approximately $4 per barrel ($102 - $98)

4. Net Result:

   • The rolling process generates losses due to the negative roll yield
   • The producer effectively sells high and buys low repeatedly, but in this case, they're selling at progressively lower prices

Therefore, the correct answer is A. Losses due to the roll yield because the contango market structure causes negative roll yield when rolling futures positions forward.