August Energy Hedging Q&A - Diesel Fuel & Natural Gas

A few weeks ago, we asked you, the wonderful readers of our blog, if you had any questions or issues related to energy hedging that you would like us to address in a future post.  Without further ado, here are our answers to a few of the questions we received...

What diesel fuel hedging strategies would you recommend to a rock mining company?

For starters, companies in all industries, including aggregates, need to be proactive with regard to developing a fuel hedging policy and strategy(s).  Economic conditions, market volatility, decreased credit availability and the impact of pending regulatory changes and financial reforms could have a major impact on your hedging initiative.

In terms of specific fuel hedging strategies, you need to begin by asking and answering the following questions?

  • Why are you hedging?
  • What specifially are you hedging?
  • What period of time do you want or need to be hedged i.e. 6 months, 1 year, etc.

From there, you can then begin to examine whether you want to hedge with exchange traded and/or cleared instruments or if you want to hedge with over-the-counter (OTC) instruments with a financial institution or trading company.

Once all of the above have been addressed, it would be wise to consider futures, swaps, call options and possibly collars.  Futures and options, including collars, are available on heating oil (the “default” product used to hedge diesel fuel) while swaps, options and collars on both heating oil and diesel are available in the OTC market.  Note that hedging diesel fuel with heating oil does expose you to basis risk.

We’re an E&P company in Louisiana that has never hedged and does not have a formal hedging policy or plan in place but we know we need to be hedging and we want to do it right.  Where do we begin?

The best and easiest way to ensure that you are heading down the right path would be to contact us and let us assist you. Having said that, as noted in the previous question, the key to hedging “correctly” is to develop an official hedging policy which addresses your risk tolerance, reasons for hedging, approved hedging strategies, approved counterparties, etc. See this post (Our Thoughts on Developing an Energy Hedging Policy) for a more thorough discussion on this topic.

I'm the CFO of food processing business and am looking for way to control and budget our natural gas costs. 

Since we don’t know a whole lot about your business, the location of your plant(s), your risk tolerance, etc. we can’t do much more than make generalizations but, generally speaking…

For starters, assuming you are in a deregulated market or you gas consumption is large enough that you are able to purchase it from a third party supplier, you want to make sure that your cost is based on a transparent price index (benchmark) such as Platts' Inside FERC's Gas Market Report.  By purchasing your gas based on a transparent index you can ensure that you are receiving a competitive price.  

From there, you should consider all of the hedging possibilities that are available to you, including a fixed price using futures or swaps, a capped price using call options or perhaps a collar, which entails the combination of buying a call option and selling a put option, thus establishing a ceiling and a floor.

All of the above are general ideas and suggestions and should not be considered as specific hedging advice or recommendations.  If you’re looking for specific heding advice and recommendations, contact us, we’d be glad to help.

If you have a question that you would like us to address in a future post, please post it in the comments or send us an email.

Last but not least, if you're in the E&P business, we'd once again like to invite you to attend the workshops we're putting on next month in Austin and Corpus Christi.  More information is available here.