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Market Stance
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we wait all summer for, when the weather
gets cold and the days get short. Now is the
time to take advantage, and make as much
money as possible.
Yet this is also that time of year that we
get so busy wearing those multiple “hats”
(managing personnel; keeping the trucks on
the road; responding to needy customers)
that we often miss opportunities staring us
directly in our face. The vehicle delivering
those opportunities is actually the nemesis
that we complain most about, market
volatility. By focusing so much on the daily
movements of the NYMEX we often miss
that other important price mover, basis.
When making purchasing decisions,
the old crystal ball is not enough anymore.
Instead, shift your attention to basis, or the
difference between your price and the New
York Mercantile Exchange (NYMEX), to
guide your procurement strategies.
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Basis is much more predictable, and
is a better representation of the physical
markets. To get a good gauge, compare
your rack price to the NYMEX for a period
of time. If over that period, rack prices are
10 cents higher than the NYMEX close,
you can use that as a starting point. Buyer
be aware! Due to the contract specification
change on the NYMEX, differentials have
been quite volatile, so be sure to adjust your
forecasts often.
Now that you’ve decided on a good filter
to identify potential opportunities, what is
the best system? It depends on a couple of
things, but most importantly, how does the
basis on your bulk offer compare to the fore-
casted number? Regardless of your “deal of
choice,” always compare your offer to what
your basis has been the past several days.
Know your options! Short-term options
are an important tool, and can be opti-
mized to minimize associated costs while
maximizing value. Short-term options
are significantly cheaper than long-term
options – those used to hedge cap pro-
grams. Options for a week or less can cost
approximately 3 cents. Below I am going
to go over a few scenarios that warrant the
use of short-term options.
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As we’ve seen lately, bulk offerings have
been generous, often beating rack basis by
several cents. When this anomaly occurs,
you might consider getting long physical
gallons. However, consider the downside
risk if prices fall. You may be beating your
rack basis by 3 cents on a given day, but
what happens if the market drops by 10
cents over the next couple of days? Here the
dealer will forfeit any expansion in margin
received – assuming the rack basis reverts
back to the mean.
Let’s look at an example for this scenario:
‘Company A’ receives their evening fax, and
the rack price is $3.10, as the NYMEX closed
at $3.00 on that day; thus, having a 10 cent
rack differential. The next day the market
plunges 7 cents to $2.93, and the decision
is made it’s an optimal time to get a bulk
quote. To their surprise they receive a quote
for $3.00. This gives them a differential of 7
cents – 3 cents below what they typically pay.
They decide to go ahead, and make the com-
mitment. On that day, the market finishes
down 7 cents, and their new rack price is
$3.03. They have effectively beaten the rack
by 3 cents. All is fine, except the next day the
market settles down 5 more cents- giving
them a new rack price of $2.88. Their slick
deal from the day before is now above rack!
Meanwhile, “Company B” used the 3
cents “discount” off the rack and used it
to finance an ATM put option. Their cost
would still be $3.03 – the same as the rack.
However, on the 2nd day, when the market
settled down 5 cents, their cost would be
$2.98 – their rack cost ($3.03) less 5 cents
from the put option. Still the same price as
the rack! Now, should the market bounce
higher, they will be locked in no higher than
$3.03. Obviously, if they didn’t purchase the
put option, the cost would be $3.00, but they
wouldn’t have had downside protection.
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Now, let’s review an example of when
the bulk basis is higher than the forecasted
rack basis. We’ll use the same starting
figures of $3.00 for the NYMEX, and a 10
cent differential. The market drops 7 cents,
from $3.00 to $2.93, but in this case they
only see a 4 cent cheaper bulk offer of $3.06
($3.10-$0.04). Since margins are really
strong, and they are keen to lock them in,
a decision is made to purchase the bulk
anyway. Assuming the market settles down
7 cents, the rack price for the following day
would be $3.03 and the bulk price would be
at $3.06! They effectively paid 3 cents extra,
or a 13 cent differential, to get a fixed price.
Let’s review an alternative strategy:
Purchase a call option for 3 cents/gallon and
buy oil at the rack price every day. When the
rack price is $3.03, assuming a 10 cent basis,
they will be paying that plus the 3 cents they
spent on the option ($3.06). The net cost will
be the same as the prompt ($3.06). Now let’s
review what happens if the market drops 5
cents the next day. With the call option they
will be able to log on to the portals, and take
advantage of the cheaper rack. In this case,
if the market drops 5 cents, they are able to
purchase bulks for that day 5 cents cheaper
their cost would be $3.01 ($2.98+$0.03);
effectively beating the bulk price by 5 cents.
If the market rebounded the following day
they would still be capped at $3.06, as with
the bulk strategy.
So while short-term hedging may come
off as the old “buy low, sell high” method,
you can see there’s more to it. The use of
short-term options can turn the odds in your
favor, and give you the competitive advan-
tage you’ve been seeking – without taking on
significant risk! There’s more than one way
to skin a cat! Know your options.
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By Jarrod Robinson, Hedge Solutions
