22 • OIL
&
ENERGY
Hedging Guidance Adds Valuable Perspective
By Rick Trout, Account Executive, Hedge Solutions
WHEN MOBIL OIL TRANSFERRED ME TO NEW
England in the early ‘90s to work in the
Distillates Department, price protection
programs offered by heating oil retailers to
consumers were in their infancy. As with a
lot of start-up programs, the offerings were
not complex and the hedges that backed up
these offers were, likewise, simple.
Mobil promoted three programs: fixed
price, cap price and collar price. Collars
were rare, perhaps because it was perceived
as not simple enough and an unnecessary
middle road between fixed and cap. Basis
risk existed, but not if you used supplier
wet barrels in your hedges.
Supplier diffs (amount over the NYMEX
price) were 3 cents and optional premiums
(for downside protection) were 4 to 5 cents.
Programs ran from October through March,
and almost everyone hedged to a projected
sales volume. Retailers were typically not
hesitant to carry their own water when
it came to crafting their price protection
programs and purchasing hedges to cover
these offerings.
HARDER THAN YOU THOUGHT
Then a not so funny thing happened over
time. Unforeseen risks appeared and lessons
were learned the hard way. Occasionally
hedges were purchased, and the market
tanked before much of the volume was sold
to consumers or after the program was well
sold. The market plunged, and consumers
reneged on their commitments and capped
gallons were hedged with call options.
Rack prices blew out so that option gains
only partially covered rack price increases.
It was not rare for retailers to take substan-
tial financial hits.
Concurrently, the futures market
evolved in unhelpful ways. In the late ’90s,
a series of equity and commodity market
bubbles commenced: first the technology
bubble, then the housing bubble and now
the Fed bubble. Bullish sentiment and
speculation drove futures prices and option
premiums to unrealistically high levels,
followed by catastrophic crashes when the
bubbles burst.
Now supplier diffs above 10 cents are
not rare and option premiums in the area
of 20 cents are considered attractive. The
latter must be passed on to consumers,
which dissuades many from opting for
capped price protection (they’re protected
against price increases and participate in
price decreases), the very program that sup-
pliers and heating oil retailers sorely need
in today’s market environment.
HELP IS AVAILABLE
Given current complexities, risks and
costs, it’s no wonder retailers are appre-
hensive and disgruntled about retail price
protection. Many probably wish that it
would go away, but they know that, done
skillfully, it can be of great benefit to their
customers, and exceptional customer ser-
vice is a hallmark of successful heating oil
dealers (and something foreign to natural
gas suppliers).
Fortunately, price protection and
hedging are not an all (do it all yourself)
or nothing (don’t do it at all) proposition.
Consultants, with considerable price pro-
tection and hedging expertise, are available
to help retailers navigate the complexities
and minimize the risks and costs.
MUCH TO OFFER
You have many responsibilities, while
hedging consultants have a singular focus.
They have encountered a myriad of price
protection and hedging issues, learning the
best ways to deal with these issues in the
process. For example, they offer clients rec-
ommendations such as what months price
protection programs should cover, and what
months should be incorporated into budget
payment plans. They also offer advice on
how and when to layer-in hedges, when to
protect against basis blowout, whether you
should hedge to sales projections or actual
sales (or a combination of the two). This
barely scratches the surface of available
advice. Learning from the experience of
others can be far less painful than learning
on your own through trial and error.
One of the signs of a skilled consultant
is the utilization of a sophisticated, comput-
erized modeling tool. While basic hedging
concepts may be intuitive, the degree of
impact that a contemplated hedge will have
on profitability is most effectively deter-
mined viamodeling. If that impact falls short
of objectives, the hedge can be adjusted
and re-modeled until the desired result is
nearly, or fully achieved. A tool such as this
can also be used to model unorthodox sce-
narios, such as hedging caps with only wet
barrels or hedging fixed price sales that may
experience considerable consumer defaults
in the event of severely falling prices.
A good consultant has the tools and experi-
ence to analyze a wide range of variables.
A competent consultant is familiar
with concepts other than price protection
program hedging such as how to identify
in-season margin spikes, and devising
and implementing short-term hedges for
extending these lucrative margins. The
core of the heating season is only about 110
days, so extending particularly high mar-
gins a few times during the winter, totaling
15 to 20 days, has a significant positive
effect on profitability. Ironically, this short-
term hedging takes advantage of market
volatility, the very nemesis that makes price
protection program hedging a challenge.
Another consulting benefit is abundant
communications. Most importantly, you
should be advised, in real time, regarding
the direction and magnitude of NYMEX
price moves and what is causing them.
Daily market recaps and market advisories
that you can send to your commercial cus-
tomers are also helpful.
NO HIDDEN AGENDA
A crucial consideration is the con-
sultant’s commitment to look after your
best interests. When a wet barrel supplier
advises you, they are most interested in
selling you heating oil. When an options
merchant counsels you, they are biased
towards advice that causes you to purchase
options. On the other hand, a consultant
recommends what is most beneficial for
you, with no hidden agenda. The consul-
tant is fixated on your success, your profit-
ability and your peace of mind.
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