$85 Oil: An Ideal Hedging Opportunity?

As crude oil and refined products have declined significantly in recent days and weeks, we've received numerous inquires as to whether we think current oil and fuel prices present a good hedging opportunity.  As is often the case, the answer is, it depends...

Regardless of whether you're an oil producer, refiner, marketer or consumer, your hedging decisions need to be based on the goals of your hedging program, risk appetite (or lack of), financial position, etc.   If you primarily base your hedging decisions on your view of current or future prices, you've no longer a hedger, you've become a speculator.

On the other hand, we're not suggesting that you should ignore what's currently happening in the energy markets, nor the global financial markets.  Significant price moves can certainly present ideal hedging opportunities but, without a solid "game plan," how can you determine if $85/BBL (or any price for that matter) is an ideal price at which to hedge your exposure?

If you're an oil producer you're probably wondering if you "missed the boat" when WTI was trading over $100/BBL as little as two weeks ago?  Only time will tell but your answers to the following questions should help your decision making process.

• Why do you hedge or are you considering hedging?  Do you need to ensure that you can service your debt?  Are you hedging to meet your budget goals?  Do you simply need an insurance policy that will cover you if the market collapses?
• What instruments are you using to hedge? Swaps, put options, costless collars, a complex structured deal that was accompanied by a slick sales pitch? More importantly, why is that your hedging instrument(s) of choice?
• What impact will hedging at $85 have on your cash flow if prices run back up to $100?  What if they decline to $50?  Recall that it was only a two and a half years ago when oil traded near $150 and subsequently collapsed to the $35 range. 

Conversely, if you're a large fuel consumer, you're probably wondering whether you should "take advantage of the dip"?   Sure, heating oil futures have declined about thirty-five cents from the recent high but, what does that really mean to you when you look at the big picture?

• What are the goals of your fuel hedging strategy?  To meet budget? To smooth out the price "roller coaster"?  To protect profit margins?
• If you enter into a hedge today for the next twelve months, how will it impact you if fuel prices decline another thirty-five cents in the coming weeks?  Is it simply a lost opportunity cost or would it have a significant impact on your business?
• What is the risk vs. reward?

Clearly there are a lot of questions that need to be answered before one makes any significant hedging decisions but, if you ask and answer the right questions, you will significantly increase the probability that your hedging program will meet your goals.  If you'd like to discuss your specific situation, give us a call, energy hedging is our bread and butter.