August 2013 • 37
taneously buying put options. If market
prices rise, the retailer lifts fixed price
rack gallons for delivery to price-capped
customers (the option expires worthless).
If prices fall, the retailer receives an option
payout that he applies to the gap between
the fixed rack price and the lower price of
gallons delivered to customers.
Here again, the heating oil company and
its customers both enjoy protection against
rising and falling prices. Furthermore, the
wet barrel part of wet barrels plus puts pro-
tects against rack price blowout and product
availability problems (suppliers typically
honor contract gallons ahead of non-contract
gallons). That’s four solid benefits associated
with wet barrels plus put options.
If four benefits aren’t enough, there’s
a possible fifth that some retailers will opt
for: buying wet barrels plus puts that are
priced 5 to 10 cents below the market (out
of the money). Out-of-the-money affects the
amount of the option premium. Five-out
are less expensive than at the money and
ten-out are cheaper than five-out. If you
lower the premium, you are in a position
to lower the cap fee to end-users, which
should make them less resistant to buying
price-capped gallons.
If you are attracted to this strategy,
it is important that you understand the
following: going out of the money assumes
that wholesale and NYMEX prices fall
faster than retail prices. For example, if you
have a five-out put option, the NYMEX is
5 cents above your strike price and your
daily delivery price is at your cap price, the
out-of-the-money strategy requires that the
NYMEX price falls 5 cents (the option starts
to pay out) before competition forces you
to lower your posted price (the cap starts
to pay out).
FIXED PRICE BY DEFAULT
Despite the many benefits associated
with cap price gallons, including reducing
the cap fee somewhat, reality is that a seg-
ment of your customers will still gravitate to
fixed price gallons. In that case, you should
consider the following: (1) offer a lower
price for pre-paid fixed price gallons so as to
maximize pre-paids, (2) offer budget fixed
price gallons at a higher price, with budget
payments over no more than 8 months and
ending no later thanDecember and (3) to the
extent that (1) and (2) aren’t doable, charge
an even higher price and use the additional
revenue to buy 20 cent out-of-the-money
put options under 10 to 20 percent of the
unpaid fixed price volume projected for
the January through April time period
(customer default insurance). If the
market crashes, you’ll have
unhappy customers (the
nature of fixed price in a
falling market), but at least
you’ll stay in business.
In conclusion, at the
beginning of this article, I made
a case for spiking prices. Perhaps
you’re wondering if there’s any
cause for concern about crashing
prices. In other words, should you
even be concerned about downside
risk? I believe the answer is yes.
Both equities and commodities are
in a Fed-induced bubble. Bubbles
always burst and usually not in a
soft way. The only questions are
how high will the market go before
the burst and when will it burst?
Gold, copper and emerging
market equities are examples
of bursting that is already in
progress. Are you willing to
gamble that U.S stocks and
worldwide petroleum products
won’t follow suit?
Propane
MAINE COMPANY OPENS STATE’S
FIRST PUBLIC AUTOGAS STATION
R.H. Foster, of Ellsworth, Maine,
recently opened the state’s first public
refueling station for propane-powered
vehicles, according to published reports.
The company also announced plans for
additional autogas stations in the Maine
communities of Hampden and Machias.
Roy Willis, president and CEO of Propane
Education and Research Council, attended
the dedication of the Ellsworth station.
R.H. Foster has already converted a por-
tion of its own fleet to propane, and said it
will seek to educate municipalities, school
districts and fleet companies about the envi-
ronmental and cost savings associated with
autogas, according to the
Bangor Daily News.
JUDGE HALTS WORK ON GRAFTON,
MASS., PROPANE FACILITY
Massachusetts Superior Court John
S. McCann recently issued a preliminary
injunction barring the Grafton & Upton
Railroad from developing a 320,000-gallon
propane storage and loading facility in
Grafton, Mass, according to a report in the
Worcester Telegram
. McCann prohibited the
railroad from delivering four 80,000-gallon
storage tanks or constructing any part of
the propane facility, including underground
and overhead piping. He said the railroad
must comply with the terms of a cease and
desist order issued by Grafton Building
Inspector Robert S. Berger last Dec. 12, the
newspaper reported.
PROPANE TANK MANUFACTURER CLOSES
DOORS AFTER GOVERNMENT RECALL
The Lite Cylinder Co. Inc., of Franklin,
Tenn., has elected to close its doors fol-
lowing a government recall of its see-through
propane tanks, according to a report in
The
Tennessean
. The recall affected more than
55,000 see-through propane tanks, which
were also lighter in weight than traditional
propane tanks. The Pipeline and Hazardous
Materials Safety Administration found that
the tanks presented an “imminent hazard
to public safety” due to their risk to leak
flammable gas, according to the May 24
recall order. The regulators noted several
documented cases of when the cylinders
on the company’s propane tanks had rup-
tured or failed, including one instance that
caused injuries to people in the Dominican
Republic and another instance that dam-
aged a gas grill in New Jersey.
