In a previous post, , we explored how oil and gas producers can implement a conservative hedging strategy utilizing a combination of call and put options to structure a strategy known as a three-way collars. Today we're going to explain how large fuel consumers, such as airlines, can also use three-way collars as a conservative fuel hedging strategy.
The Mercatus Energy Pipeline
Are crude oil prices headed back below $40/BBL or even $30/BBL? Prompt NYMEX WTI futures settled last night at $42.92/BBL, while prompt Brent futures settled at $44.87/BBL and both are trading lower by an additional 75 cents at the moment. Recall it was only a few months ago that we witnessed crude oil trading below $30/BBL before the recovery back above $50/BBL.
Given the recent volatility in crude oil and refined products prices, as well as natural gas prices, we thought it would be beneficial to take another look at the various energy hedging instruments available to the various participants in the energy commodity markets.
Over the course of the past year, refining profit margins have been all over the map. As an example, over the course of the past year, the WTI-NY Harbor ultra-low sulfur diesel (ULSD) crack spread has traded as high as $22.92/BBL and as low as $6.89/BBL while averaging $14.03/BBL. Crack spreads on other crude oils (Brent, Light Louisiana Sweet, etc.) and various refined products (diesel, gasoline, jet fuel, etc.) have been similarly volatile.
As many companies are currently planning for 2017 and beyond, now is an ideal time to review your energy risk management program, including whether your team is prepared for the challenges of the upcoming year. Regardless of whether you're a Fortune 500 company or a small, family owned business, you need to determine whether or not your team your team is well prepared to do all of the following:
1. Identifiy, Analyze and Quantify All Risks
In the first post in this series, Bunker Fuel Hedging & Price Risk Management - Swaps, we examined how companies in the maritime and shipping industries can hedge their exposure to volatile bunker fuel prices with a strategy known as a fixed price swap.
The need for effective hedging and marketing is greater in the current price environment i.e. $50/BBL than it is in a higher price environment i.e. $100/BBL. Indeed, high prices can mask the consequences of poor commodity price risk management. At $50/BBL, oil and gas producers are greatly exposed to price volatility. Every $1 change in the price of oil is felt more intensely at these levels because margins are quite thin, many producers’ credit facilities are maxed out and lenders are nervous. Most producers are conflicted: they face real risk of lower prices, but they fear missing out on higher prices, and they have limited hedging budgets. Budgets are squeezed, but price risk remains present.
This post was originally written several years ago but has been updated several times since then as it is regularly referenced in other articles regarding oil and gas hedging with three-way collars i.e. Oil Crash Exposes New Risks for U.S. Shale Drillers.
This post is the second in a series where we are exploring the various hedging strategies which are available to commercial and industrial natural gas consumers, also known as end-users. You can access the first post via this link - An Introduction to End-User Natural Gas Hedging - Part I - Futures. In subsequent posts we'll explore how commercial and industrial natural gas consumers can hedge with options, basis swaps and more complex instruments.