Posted on Mon, May 14, 2012
As we've previously discussed, the CME/NYMEX has decided to keep the existing heating oil futures contract, which was previously due to be discontinued in April 2013 (originally January 2013) and to transition from the current low sulfur product to an ultra-low sulfur product. For more background information, see our previous post, CME to List Heating Oil Futures Beyond April 2013
Last week the CME issued a update stating that the transition from low to ultra-low sulfur heating oil futures will begin on April 29, 2012 with the May 2013 contract. The specifications will be the same as the specifications for Colonial Pipeline’s Fungible Grade 61 for ultra low sulfur diesel (ULSD). The full details are available on the CME website.
In addition, while it hasn't been well broadcast to the market, the CME recently listed additional months in heating oil futures, which currently extend to January 2016.
It's worth noting that just because the exchange is announcing the transition is not to say that an ULSD HO contract will attract the liquidity of it's older sibling. Due to the ongoing changes in refining, as well as increasing in fuel consumption in the developing world, it's very well possible that, in due time, the Gulf Coast ULSD contract could become the dominant distillate futures contract in North America.
On the other side of the pond, it appears that market participants aren't rushing to transition from ICE's high sulphur gasoil futures to the new, low sulphur gasoil futures. Since it's debut in early February, the low sulphur contract has yet to attract much liquidity. As of the close of trading on Friday, the June and July low sulphur gasoil contracts only had about 3,000 lots of open interest vs. the traditional gasoil June and July gasoil futures which has an open interest of about 247,000 lots.
So what does this all mean for those who hedge their distillate fuel risk with futures, swaps or options on heating oil and/or gasoil? At the moment, not much, but prudent risk managers will keep all an eye on all of the relevant contracts as it is inevitable that the much of the liquidity will eventually transition to one or more of the newer contracts.
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Posted on Wed, May 09, 2012
It was only a few weeks ago that many analysts were calling for crude oil to continue to trend towards $150 per barrel. Today many are saying that the trend seems to have reversed course and prices may very well be headed in the opposite direction. Earlier this week, the prompt month (June) Brent crude oil futures traded at their lowest level in since late January. Today, the prompt month WTI crude oil futures traded at their lowest level since mid December. Which has many wondering, are crude oil prices headed lower or is this simply a minor pullback amidst a longer term bull market?
For many large fuel consumers with active hedging programs, trying to predict where oil and fuel prices are going to be trading a month or year from now is one of their most difficult tasks, but this shouldn't be the case. Hedging decisions shouldn't be based on one's view of the market, as nearly all market participants are inevitably proven wrong, often in spectacular fashion (see this article on SemGroup for an example). If accurately forecasting oil prices were such a simple task, many of us would be earning a very nice living trading crude oil futures from the comfort of a luxurious beach home.
So if being able to accurately predict future oil prices isn't the key to a successful fuel hedging success, what is the key? In simple terms, sound risk management. If you were to buy a one year Brent crude oil swap today, how will it impact your bottom line if crude oil prices do indeed trend lower over the next year? Does locking in fuel costs at the equivalent of $110/BBL (or say, $3.00/gallon or $950/MT) allow you to lock in acceptable, or better yet, strong profit margins, regardless of where oil prices between now and next May? How would owning a $110 swap impact your cash flow if Brent averages $90 over the next year? Might it make sense to pay a $5/BBL premium to ensure that if prices do head higher than you will pay no more than $110/BBL but if prices move lower you will retain the ability to benefit from lower prices? After all, Brent has declined by $10/BBL in the last two weeks. Given the incredible amount of uncertainty in the oil markets, these are the types of questions that one must ask if the ultimate goal of your hedging program is hedging against oil price volatility.
What will happen to oil prices if the economic situation in the European union continues to deteriorate? What about an oil supply disruption in a large producing region such as the Middle East? What if US monetary policy causes the dollar to decline significantly? These are questions which need not be answered with precision if one is managing a sound fuel risk management program, as such a program will put you in a position to know how both higher and lower oil prices will impact your bottom line and cash flow, regardless of what variables are influencing the oil market. Clearly, reality isn't so simple but it can't be denied that fuel hedging programs which are successful over a long period of time aren't so as a result of outstanding commodity market knowledge but, the ability to make sound risk management decisions in various market conditions.
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Posted on Tue, May 01, 2012
As we've recently received inquires from several airlines who are looking to begin hedging their jet fuel price risk for the first time, we thought it would be beneficial to address the basic jet fuel hedging strategies available to airlines.
As this post will be the first of several in a series, we'll start with jet fuel swaps as buying jet fuel swaps is often considered the "most basic" hedging strategy for airlines. In subsequent posts we'll address how airlines can hedge their fuel risk with call options, basis swaps, collars and spreads on options.
A jet fuel swap is an agreement whereby a floating (or market) price is exchanged for a fixed price, over a specified period(s) of time. In addition to jet fuel, swaps are also used to hedge numerous other commodity risks incluing bunker fuel, crude oil, diesel fuel, electricity, natural gas, etc. The term "swap" is used to describe the trade as the buyers and sellers of a swap are “swapping” cash flows.
Airlines hedge with jet fuel swaps in order to fix or lock in their jet fuel costs, while refiners can utilize jet fuel swaps in order to lock in or fix their profit margins, also known as crack spreads. Similarly, swaps are also utilized by companies seeking to hedge their exposure to foreign exchange rates, interest rates and numerous other commodity price risks as well.
As an example of how an airline can utilize a jet fuel swap, let's assume that you're an airline who consumes a large amount of jet fuel in Asia and you have decided to lock in 50% of your fuel costs for a specific month as you have already sold 50% of your available seats during said month. For sake of simplicity, let's assume that you are looking to hedge 10,000 BBLs of fuel which will be consumed during the month of June. In order to do accomplish this you could purchase a June 2012 Singapore jet fuel swap, on 10,000 BBLs, from your counter-party (often a major oil company or bank). If you had purchased this swap today at the prevailing market price, the price would have been (approximately) $133.35/BBL.
Now let's look at how the swap would perform if the average price of jet fuel during the month of June averages both $10 per barrel lower and higher than the price of your swap, $133.35/BBL.
In the first scenario, let's assume that jet fuel prices in Asia decrease and that the average price for Singapore jet fuel, (as published in Argus Asia-Pacific Products or Platts' Asia Pacific/Arab Gulf Marketscan) for each business day in June, is $123.35/BBL. Given the $10/BBL decrease, your hedge at $133.35/BBL would result in a "loss" of $10/BBL or $100,000. As a result, you would owe your counter-party $100,000, which would offset the decrease in your actual June fuel cost by $10/BBL on 10,000 BBLs.
In the second scenario, let's assume that jet fuel fuel prices in Asia increase and that the average price for Singapore jet fuel, for each business day in June, is $143.35/BBL. In this scenario, your hedge would result in a “gain” of $10/BBL or $100,000. As a result, your counter-party would owe you $100,000, which would offset the increase in your actual June fuel costs by $10/BBL.
As this example shows, purchasing a jet fuel swap allows an airline to hedge their exposure to volatile jet fuel prices and lock in their profit margins. If the price of jet fuel increases, the gain on the jet fuel swap offsets the increase in the airline's actual jet fuel cost “into the plane". On the other hand, if the price of jet fuel decreases, the loss on the jet fuel swap offsets the decrease in the airline's actual fuel cost “into the plane”. Either way, once the swap is executed, the airline has turned an unknown fuel cost into a known fuel cost, excluding basis risk. While this example addresses how an airline can use jet fuel swaps to hedge their exposure to jet fuel prices, the same methodology can also be used to hedge exposure to other fuels (bunker fuel, diesel fuel, etc.) and commodities as well.
If you would like to discuss how we can assist you with jet fuel hedging, please feel free to contact us.
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Posted on Tue, Apr 24, 2012
Today we're releasing the schedule for our summer and fall energy hedging and risk management seminars. In the past we've primarily held our public seminars in the US but, due to numerous inquires from across the globe, we are now offering our seminars in Asia, Europe and Latin America as well. Attendance is open to both clients and non-clients. For more information, or to register, please visit the following links or contact us.
Fuel Hedging & Risk Management - Houston - June 6-7, 2012
Crude Oil & Natural Gas Hedging - Houston - August 1-2, 2012
Fuel Hedging & Risk Management - Frankfurt - September 5-6, 2012
Crude Oil & Natural Gas Hedging - New Orleans - October 24-25, 2012
Fuel Hedging & Risk Management - Singapore - November 14-15, 2012
Fuel Hedging & Risk Management - Bogota - December 5-6, 2012
Discounts are available for early registration as well as multiple (two or more) registrations from the same company.
If you are unable to attend any of our public seminars and would like to discuss how we can deliver an in-house seminar or workshop for your company, please contact us.
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Posted on Wed, Apr 18, 2012
If you follow our blog, you know we're energy hedging and risk management junkies. You're also familiar with our opinions on various energy hedging and risk management practices and strategies. Curious to determine the current state of fuel hedging and risk management practices (not just what they report in their financials or company presentations but the nuts and bolts) of numerous airlines across the globe, we surveyed them to get the answers direct from their executives.
Among the questions that we asked the airlines:
- Who is responsible for making your fuel hedging and risk management decisions?
- What hedging strategies do you employ (swaps, call options, etc.)?
- Who are your counter-parties (international financial institutions, major oil companies, etc.)?
- What sources do you use for hedging and risk management advice, data and information?
- And more...
We've just compiled the results in a newly released report, titled “The State of Airline Fuel Hedging & Risk Management,” and we'll be telling you about some of the more interesting findings on our blog - now and down the road.
The study resulted several key findings about the current state of fuel hedging and risk management among commercial airlines, including the following:
Finding #1: Many airlines know they need to improve their fuel hedging initiatives but aren't taking the appropriate actions.
39% told us that they do not utilize hedging strategies which accurately reflect their risk tolerance and/or corporate goals. Another 22% said that they need to establish a more consistent approach to fuel hedging and risk management.
Finding #2: The majority of airlines rely solely on their banks for hedging advice, data and information.
68% reported that they rely solely on their banks to provide them with hedging and risk management advice, data and information, indicating that many airlines have yet to adopt energy hedging and risk management best practices.
We'll be the first to admit fuel hedging is far from a simple task but, based on what the airlines told us, many of them are well aware that they have a lot of work to do to ensure that their fuel hedging programs are successful and meet best practices, yet they aren't taking action.
That being said, we were very impressed by a several of the airlines, as they are doing nearly everything they should be doing to effectively manage their exposure to volatile fuel prices. Hopefully we will be able to say the same about many of their peers in the not too distant future.
That's all for now but the full report is available via this link:
The State of Airline Fuel Hedging & Risk Management
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Posted on Wed, Apr 11, 2012
As has been well reported elsewhere, Delta Airlines is rumored to be in negotiations to buy ConocoPhillips' Trainer, Pennsylvania refinery in order to better manage the airline's exposure to volatile jet fuel prices.
Our thoughts on the story are pretty similar to everyone else who is questioning the idea, including Tom Kloza of OPIS, who had a pretty entertaining quote in the NY Times article, “It's a little like a rabbi buying a church".
If you're not familiar with the story, here are a few links:
Delta Air mulls bold bid for Penn. oil refinery - Reuters
Delta Air Could Buy Conoco's Trainer Refinery For $100M-$150 Mln - Wall Street Journal
Refinery Gets a Look From Delta, Perplexing Analysts - NY Times
Delta linked to bidding for oil refinery - Atlanta Constitution-Journal
Have you heard the one about the airline that buys a refinery? - Houston Chronicle
The Glue in Delta’s Possible Refinery Deal: JP Morgan - CNBC
Possible Delta Air Lines Refinery Acquisition Raises Eyebrows - Energy Risk
When the story first broke, we asked several airline executives for their thoughts and all of them thought the story had to be some sort of joke.
Nevertheless, we'll applaud Delta for attempting to think outside of the box but, it's hard to imagine that their shareholders will agree that this is a sound business or risk management decision.
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Posted on Mon, Apr 02, 2012
As many organizations are struggling with high fuel (gasoline, bunker fuel, diesel fuel, jet fuel, etc.) prices, one hedging strategy which isn't often utilized, but may deserve consideration, is a participating fuel swap.
In essence, a participating swap is the combination of swap and a put option. What makes a participating swap different than the combination of a swap and a put option is that with a participating swap, the premium for the put option is embedded into the price of the swap. As such, the buyer of the participating swap accepts a higher price on the swap in exchange for not having to make an "out of pocket" payment for the put option.
As an example, let's assume that you are looking to hedge your June diesel fuel exposure of 100,000 gallons. In addition, let's also assume that you are equally concerned that oil (and diesel fuel) prices could decline significantly due to weak economic conditions.
As a result you decide to hedge your June diesel price risk with a June $3.35 heating oil 50% participating swap. The participating swap is attractive because of the following:
A) It protects you against rising diesel fuel (heating oil) prices
B) If heating oil futures average below the price of the swap, only 50% of your fuel is hedged at $3.35
C) You do not have to pay for the put option (the participating component of the swap) upfront as the premium is embedded into the price of the swap
Moving forward with this example, if prompt month heating oil futures during the month of June averages more than $3.35/gallon, you will receive a payment from your counter-party which is equal to the average price, minus $3.35, multiplied by 100,000 gallons. As a result, this means that if the average price is over $3.35, you net cost will be $3.35/gallon.
Conversely, if prompt month heating oil futures during the month of June averages less than $3.35/gallon, you will receive a payment equal to $3.35 minus the average price, multiplied by 50,000 gallons (100,000 X 50%) from your counter-party. As a result, this means that if the average price is below $3.35, you net cost will be $3.35 on 50,000 gallons (50% of 100,000 gallons) and the average price on the other 50,000 gallons (50% of 100,000 gallons). As an example, if the prompt month heating oil futures during June average $3.00/gallon, your net cost would be $3.175/gallon.
As the example indicates, the participating swap is very similar, yet different, than the combination of a swap and a put option. The are two primary differences:
1) If you were to purchase a fixed price swap on 100,000 gallons and a put option on 50,000 gallons, you would be required to pay an upfront premium of $0.10/gallon for the put option.
2) If you were to purchase a fixed price swap, the swap price would be $2.25 ($3.35 - $0.10) as the cost of the put has been embedded into the swap, thus making the participating swap 10 cents higher than the going market price for a June, average price, heating oil swap.
Note: This example ignores the basis risk between cash diesel fuel prices and heating oil futures.
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Posted on Wed, Mar 28, 2012
As fuel hedging consultants, we're often asked: "What are the most common mistakes companies make when it comes to fuel hedging?" The following is our top eight list as well as our take on each:
8. "We quit hedging fuel because our hedging program never made money." Hedging isn't intended to and shouldn't be considered a source of revenue. A proper fuel hedging program should provide one or more of the following:
- Protection against rising fuel prices
- Cost certainty
- A known or maximum fuel cost for budgeting purposes
- Ability to lock in a profit margin
7. "Hedge but don't lose money." The vast majority of fuel hedging mistakes and losses are the result of a poor or nonexistent fuel risk management policy and/or the lack of well designed fuel hedging strategy(s). Most hedging mistakes can be avoided if you take the time and effort to create a sound risk management policy and develop and implement strategies that allow you to meet or exceed your corporate hedging goals.
6. "Our management team can't agree on how high they think fuel prices are going to go this year" Hedging decisions shouldn't be made based on your opinion about fuel prices. If it were easy to predict where fuel prices are going to be a month or year from now, it's quite likely that we wouldn't be here, we would be counting our money from a beach chair in the Caribbean.
5. "We're going to wait and if fuel prices decline over the next few months." How will you react if prices increase 20% (or more) between now and then? Will you continue to wait for prices decline (remember you are already "down" 20%) or will you "cry uncle"?
4. "We only hedge when we think prices are attractive." What if attractive prices don't appear anytime soon? What will you do if $125/BBL becomes the "new normal"?
3. "We only hedge when we have a strong opinion about fuel prices." What if your opinion is incorrect? The oil markets don't tend be too fond of opinions.
2. "Since fuel prices have been increasing we're not going to hedge until prices come back down." What if prices begin to increase rapidly? Are you going to have the discipline to hedge at that point or continue to wait for the tide to turn? As has been previously mentioned, trying to forecast fuel and oil prices is most often an ill advised activity.
1. We can't afford $4.00 (or pick your price) per gallon. If you can't afford $4.00/gallon, if fuel prices continue to increase, how will you afford $4.50/gallon?
In summary, a successful fuel hedging program is the result of a sound fuel hedging policy (which includes hedging strategies that "work" in both high, moderate and low fuel price environments) and the willingness to stick with it.
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Posted on Mon, Mar 26, 2012
On Friday the CME announced that it is no longer going to de-list heating oil futures and options, which was set to occur at the expiration of the April 2013 contract. Rather than de-listing the existing contract and forcing the market to transition to the currently illiquid, NYH ULSD (ultra-low sulfur diesel) futures, CME is going to change the specifications of the existing heating oil contract, beginning with May 2013 futures. The change will mean that, beginning with the May 2013 contract, the heating oil futures specs will reflect the specs of Colonial Pipeline Grade 61 ULSD.
CME said that it has no plans to de-list the existing New York Harbor ULSD futures contract, which implies that the exchange is going to let the market decide which contract to embrace, which will most likely continue to be "heating oil", as the specs for the NYH ULSD futures are also Colonial Pipeline Grade 61 ULSD.
This is good news and something we have been advocating for quite some time as the transition to a new contract can be quite difficult when one is looking to hedge long-dated fuel price exposure. That being said, even with the continuance of the existing heating oil contract, the market will have to adapt to the new ultra low sulfur specs, which will, impact the basis relationships between the new contract and low sulfur (500 PPM) and high sulfur (2,000 PPM) distillates including diesel fuel, heating oil, jet fuel, kerosene, etc.
Nevertheless, had CME stuck with their initial decision, the market would have embraced the change, as it did when the exchange de-listed the original gasoline futures and options contracts (HU) and transitioned to RBOB gasoline futures and options (RB).
It will be interesting to see how ICE responds to the CME's decision as ICE has listed low sulphur gasoil futures and options (10 PPM), along side it's existing gasoil contracts. Like their siblings in New York, ICE's low sulphur contracts have yet to be embraced by the market, although ICE is pushing the contracts, as noted in their March "Monthly Oil Report" which stated the following:
Around thirty companies are active in the ICE LSG contract to date, which has a 2012 average daily volume (ADV) of 449 lots per day; approximately double the 2011 ADV. Counterparties who have been active in the contract include oil majors/refiners, banks, trading houses and proprietary traders.
While ICE's low sulphur contracts have certainly attracted more liquidity than the CME's NYH ULSD contract, 500 contracts per day does not make a successful futures contract. In comparison, the "traditional" gasoil futures currently trade about 250,000 contracts per day.
It's also worth noting that CME's Gulf Coast ULSD Swap Futures are attracting a good amount of liquidity (current open interest of about 7,000 contracts) and are likely to continue to do so given the ever increasing activity in the Gulf Coast markets and the numerous, other markets which trade in relation to USGC benchmarks.
Heating oil futures are the oldest, successful energy futures contract in the world, having made their debut in 1978. Interestingly, the listing of heating oil futures came to fruition as an act of desperation by the exchange. In 1976, the CFTC banned the NYMEX's core product, Maine potatoes futures, following a large delivery default by Jack Simplot, the "Idaho potato king".
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Posted on Mon, Mar 19, 2012
As crude oil and refined products prices once again seem to be on an upward trend, we've received several requests for more information on the basics of international fuel hedging, across a wide range of industries (air, heavy industry, marine, road, etc.).
As this post will be the first of several in a series, we'll going to begin with fixed price swaps (also known as fixed-for-floating swaps), which are one of the most commonly used hedging instruments in the global fuel markets. In subsequent posts, we'll also cover additional types of swaps, as well as options and other hedging strategies, which are based on more complex structures.
Given that the focus of this post is international fuel hedging, it's going to focus on hedging with gasoil swaps, based on gasoil futures, the international benchmark for distillate fuels, as traded on the Intercontinental Exchange (ICE) in London.
A gasoil swap is an agreement whereby one market participant, say an airline, exchanges their exposure to floating (or market) gasoil prices for a fixed gasoil price, over a specified period(s) of time. Swaps are called such as the buyers and sellers of swaps are “swapping” cash flows.
Fuel consumers, such as airlines, utilize gasoil swaps in order to fix or lock in their fuel costs, while refiners and fuel marketers utilize swaps in order to lock in or fix their margins, revenues and/or cash flow. Foreign exchange, interest rate and agricultural and other energy, commodity risks can be similarly hedged with swaps.
As an example of how an airline can utilize a gasoil swap to hedge their jet fuel price risk, let's assume that you're an airline who primarily flies in Western Europe and needs to "lock in" a portion of your jet fuel costs for a specific month. For sake of this example, let's also assume that you are looking to hedge 5,000 MT (metric tons) of your anticipated June fuel consumption. In order to do accomplish this, you could purchase a June gasoil swap from your bank’s fuel trading group. If you had purchased this based on the price as of the close of business on Friday, the price would have been (approximately) $1,035/MT.
Next, let's look at how the swap would perform if gasoil prices in June average both above and below your price of $1,035/MT
In the first scenario, let's assume that gasoil prices increase and that the average price for ICE gasoil futures for each business day in June is $1,050/MT. In this scenario, your hedge would result in a "gain" of $15/MT ($1,050 - $1,035 = $15) or $75,000 (5,000 MT X $15). As a result, you would receive a payment of $75,000 from your bank, which would offset the increase in your actual jet fuel costs by $15/MT.
In the second scenario, let's assume that gasoil prices decrease and that the average price for ICE gasoil futures for each business day in June is $1,000/MT. In this scenario, your hedge would result in a “loss” of $35/MT ($1,035 – $1,000 = $35) or $175,000. As a result, you would have to make a payment of $175,000 to your bank, which would offset the decrease in your actual jet fuel costs by $35/MT.
As this example shows, purchasing a gasoil swap allows airlines to hedge their exposure to volatile jet fuel prices, an expense which often accounts for somewhere between 25-50% of an airlines total operating expenses. If the price of gasoil (and in turn, jet fuel) increases, the gain on the swap offsets the increase in the actual "into-plane" jet fuel cost. On the other hand, if the price of gasoil (and in turn, jet fuel) decreases, the loss on the swap offsets the decrease in the actual "into-plane" jet fuel cost.
While this example addressed how airlines can utilize gasoil swaps to hedge their jet fuel price risk, the same methodology can also be used to hedge exposure to other distillate fuels (i.e. diesel fuel) as well. In addition, as previously mentioned, refiners and fuel marketers can also utilize gasoil swaps to hedge their fuel margins, revenues and/or cash flows.
As is always the case with fuel hedging, the devil is in the details. Furthermore, there is clearly a risk to hedging with fixed price swaps, as swaps result in a "loss" if the price of the underlying instrument settles below the price of the swap.
As many of you may already know, hedging jet fuel with gasoil swaps (as well as gasoil futures and options), subjects airlines to basis risk, a topic beyond the scope of this post. However, we will provide it the attention it deserves it in a future post.
If you would like to learn more about how you can hedge your exposure to volatile jet fuel prices with gasoil swaps or any other hedging strategies, please contact us, we would be glad to assist you.
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