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INTEGRATING HEDGING INTO COMPANY OPERATIONS Energy futures have been around since 1978. Since then, many oil companies have embraced energy price risk management through hedging. Hedging is a way to protect the value of inventory or take advantage of attractive prices in future months. Hedging is not a way to get rich quick. Many oil men understand this; many more do not. One obstacle for those who do not understand hedging is how to integrate hedging into company operations. Before this question can be answered, however, the dealer has to determine his risk. IDENTIFYING RISK Risk to the dealer depends on how the business is done. If the dealer buys at the rack, marks the oil up and resells it, he has no price risk and no need to hedge. He also relies on the market for business; he is a passive market participant. There are other risk profiles as well. Dealers may wish to sell oil at a fixed price. The dealer pre- buys oil from a supplier or using a futures contract. This assures that higher prices will not harm his position. If prices fall the customer remains obligated to pay the fixed price. If prices fall, there is a risk that customers could object to their deal. There is a hedging solution to meet this risk. Those who store product face a different risk, which is prices falling before the oil is sold. This risk has historically dissuaded many dealers from using their storage. IDENTIFYING OPPORTUNITY These are three risk profiles that illustrate the basic question the dealer must answer: What is my risk of prices moving against my position? Once the direction of risk is known, it is possible to construct a risk management profile and identify new opportunities. The passive market participant goes with the market. He accepts the status quo, but cannot take advantage of market change to grow the business. He foregoes the opportunity to sell at fixed or capped prices. Selling at fixed price using futures instruments to protect against market weakness allows sales to be made with greater safety to the dealer. In the current environment, the price of ULSD for (say) next February is about 23 cents higher than currently. A dealer who filled storage now could sell that oil at a future date and collect the dif- ference as time passed. Three different profiles offer different opportunities to grow volume or buy oil cheaply and sell at a high for future delivery. Identifying the opportunity allows a proper strategy to be developed. IMPLEMENTING THE HEDGE The decision to use hedging as a tool of business growth and protection brings into play several important factors. 1) Find competent advisory help A hedger that uses futures or options on futures must establish a commodities account. The brokerage house should have energy industry specialists with the skills needed to establish a hedging strategy. Be aware that there are many brokers that do not specialize in energy. The energy specializa- tion is in addition to the broker's primary task of executing the order and ensuring it is reflected cor- rectly on the company books. 2) Determine how much is to be hedged It's important to match the actual market exposure with how much to hedge. If the dealer is offer- ing a pre-paid or fixed price program, make sure the futures hedge is about the same as the dealer's exposure. Similarly, oil in storage should be hedged as closely as possible. A mismatch between actual oil price exposure and futures could lead to losses. Here, too, your commodities advisor or broker can be very helpful. 3) Establish an internal tracking system Balancing wet barrel and futures positions is central for management control. The hedger needs a system to ensure this balance. Satisfactory com- mercial systems have not been easy to find. Most hedgers have relied on simple spread sheets to track their positions. Dealers that adopt hedging often find that following the hedge yields benefits well beyond price risk management. For many, it is the first time they have dealt with inventory and forward commitments in any detail. For others, the ability to hedge allows them to expand marketing opportunities with financial safety. — AL LEVINE, POWERHOUSE www.fueloilnews.com | FUEL OIL NEWS | MAY 2016 31