Why Gamble on Fuel Prices When You Can Hedge?

Strategies for handling price volatility to protect profit margins.

November 23, 2020

By Keith Reid

ALEXANDRIA, Va.—Price volatility is always an issue with fuel logistics, whether you are fuel retailer, distributor or commercial fuel buyer. It is bad enough chasing rack prices each day, but what if you are moving larger quantities with greater lead times to achieve favorable pricing? The price exposure can be far more significant, making that purchase either a brilliant decision or catastrophe, depending on the whims of the market. However, there are mechanisms in place that can remove much of the risk through what amounts to price insurance.

“People say to me, isn’t hedging risky?” said Elaine Levin, president of Powerhouse, during her Crack the Code Experience Buying Smarter Despite Volatile Petroleum Prices session. “It’s really the opposite. The real risk lies in not hedging your fuel purchases. Conservative companies want to protect their precious profit margins from the unknown factors of the market, whether that be an OPEC decision, or the weather, or a pandemic.”

Powerhouse works with clients to help protect profit margins and grow their businesses by designing and implementing hedging strategies.

The session provided a solid introductory view on how hedging can play a role in fuel procurement. As Levin noted, the goal of hedging is to defend profit margin against energy price volatility to allow fuel purchasers to concentrate on growing their businesses. It’s important to note that hedging is not speculation.

“Hedging is a defensive activity,” said Levin. “If you are a speculator, you are willing to take risk in exchange for the opportunity to profit. Speculators think they know something about the future, whether that is going to the roulette table and thinking that red will come up on the next spin, or that the price of crude oil is going to go to $50. The hedger, on the other hand, says, ‘I don’t know what the future holds, and I want to make sure that my precious profit margins are preserved.’”

Speculators trade risk for the ability to profit, and the transactions are not related to an underlying physical position. It is basically an investment and is treated as investment income. Hedgers, on the other hand, try to stabilize the revenues or costs, and hedging gains or losses is part of the cost of goods sold.

What other opportunities are provided by hedging beyond pure profit protection? Distributors can establish fixed-price or cap deals for their customers with the knowledge that their fuel prices will have stability. It also allows a purchaser that is an end-user, such as a fleet, to have stable budgeting.

While introductory in nature, the session covered a range of topics. For example, it went into detail describing the fuel contract in terms of quantity, trading months, trading hours, delivery point and symbol. It focused on both gasoline and diesel.

Some of the basic language involved in futures trading was explained, such as “long” and “short.” The difference between “puts” and “calls” was described and how they counter the risk of rising or falling prices. Levin also walked through a RBOB bull call spread strategy that offers a defined profit potential while limiting capital at risk.

Levin concluded by outlining the elements of a successful hedging program that basically becomes a core operational foundation of a company’s fuel logistics.

The session is available on demand. The NACS Crack the Code Experience runs through December 4 and features 24/7 access to forward-looking ideas and insights, plus innovative new-to-channel products and strategic connections. There’s still time to register for your own Crack the Code Experience! Do so today!

Keith Reid is editor-in-chief of Fuels Market News Magazine and editorial director of Fuels Market News.