September Energy Hedging Q&A – Gasoline, Natural Gas & NGLs

Based on the positive feedback we received from the August Energy Hedging Q&A, we're going to make the hedging Q&A a permanent, monthly feature.  The following are few of the hedging questions, as well as our answers, that we’ve received since last month's post.  If you would like us to provide a more in depth answer to any of these questions or if you’d like to ask us a question for next month’s Q&A, let us know. 

How can a fleet hedge our gasoline costs? 

This is a pretty broad question but in simple terms, a gasoline end-user (including fleets) can hedge with gasoline futures or options on the NYMEX or with over-the-counter (OTC) swaps or options.  If you are looking to “fix” your cost, you would typically purchase gasoline futures or swaps.  If you are looking to cap your cost, you would typically purchase gasoline call options, either exchange traded or OTC.  On the NYMEX, the gasoline futures and options trade in lots of 42,000 gallons (1,000 barrels) per month.  In the OTC market, 42,000 gallons/month is also the standard but if you needs are more or less than 42,000 gallons per month, some market makers than will provide swaps and options whose volume is “customized” to meet your needs.  In addition, if you choose to hedge with NYMEX futures or options (or OTC swaps or options based on NYMEX gasoline) you need to understand that you will remain exposed to basis risk (see the link for more information on basis risk).

We’re a natural gas producer and want to begin hedging but our bank doesn’t offer hedging and we don’t want to post the margin required to hedge on the exchange, what are our other options?

This is actually a question we receive on a semi-regular basis.  There aren’t any easy answers but the easiest are as follows:

You can inquire with the company(s) that purchases your production to determine if they are able to offer you swaps, options, fixed forwards, etc. either in conjunction with your physical production or as a stand alone financial hedge.

Talk to your bank about establishing an inter-creditor agreement with another bank or trading firm that does provide natural gas swaps and options.  Essentially, if your bank has or is able to establish an inter-creditor agreement (assuming you have an adequate amount of credit available) with another counter-party, then you should be able to hedge though the counter-party that has entered into the inter-creditor agreement with your bank.

Similar to the inter-creditor agreement, you bank may be able to provide a letter of credit that will allow you to trade with the counter-party of your choice, assuming said counter-party is willing to accept the letter of credit.

Better yet, give us a call or shoot as an email so we can learn more about your situation as we can probably point you in the right direction once we know the details. 

We need to hedge our NGLs, should we be hedging with crude or natural gas?  Also, should we use swaps or options?

It depends…Are you a producer, marketer, processor (midstream) or end-user?  In most cases we would suggest that you consider hedging your NGLs with NGLs as there is a fairly active market for Mont Belvieu and Conway NGL derivatives.  In the OTC market, swaps and options (although the options aren’t too liquid) are traded on propane, ethane, butane and natural gasoline.  If you’re looking to place hedges that go out further than the liquidity in these markets,  then you could consider hedging with crude or natural gas but you have to realize that doing so is at best a “dirty hedge” and comes with an entirely different set of challenges i.e. correlation and basis risk.  Regarding the swaps vs. options question, it’s impossible to say without knowing more about your business, risk tolerance, etc.  Having said that, generally speaking, if you are trying to “lock-in” a price or margin, swaps are, most often, the appropriate hedging instrument.  On the other hand, if you need to hedge against an upward or downward price move but need/want to retain upside or downside exposure as well, you should probably be looking at options.  Give us a call, we’d be glad to help you figure it out.

If you have a question that you’d like us to answer as part of next month’s hedging Q&A, please feel free to post it in the comments or contact us.  Anonymous questions are more than welcome.