Fuel Hedging: Aggressive or Moderate?

Face-off is a regular feature in Convenience Store Decisions that gives retailers, suppliers and consultants an opportunity to debate the issues affecting the convenience store and petroleum industry. Have an idea for Face-off? Contact John Lofstock at 201-845-2468 or via email at jlofstock@penton.com.

Philip J. Baratz, C.T.A.
President, Angus Energy Inc.

Hedge Your Risk
As someone who has managed well over a billion gallons of hedging for retailers, gasoline jobbers and natural gas marketers, I figured that it would be easy to write a brief commentary on the “pro-side” of risk management for retailers.

Retailers live and die by their pump margins. The absolute price of the gasoline, while not inconsequential, pales in comparison to the importance of the margin that can and will be achieved by selling that gasoline to the consumer. Typically speaking, when prices rise—especially if the increase is quick and unexpected—margins have a tendency to shrink. Conversely, falling prices often accompany widening margins. Changes in margins used to be tracked over weeks, and sometimes, months. Now, the volatility of all petroleum prices, especially with the myriad of gasoline specifications, has caused often dramatic changes in daily profit margins.

So, simplistically speaking, if spiking prices are bad and falling prices are good, the “logical hedge” would be to protect against a sharp increase in prices over a short period of time. A very basic hedge might be used to simply track each day’s price and protect against a quick jump during the following day. Without going into the logistics of options, basis differentials, and time values, the basic premise is to figure out whether the cost of protecting against a drop in profits, caused by a spike in prices, is worth it. There are many different approaches, ranging from storage and supply management, to refinery margin hedges, to simple short-term spike protection. Each approach addresses different areas of potential concern.

As mentioned, I am a very big believer in hedging—but that might also turn out to be a problem. Hedging is neither good, nor bad. Hedging is about expectations and reality. Or, more to the point, as hedging decreases, speculation increases. So, to clarify, I am not so much a proponent of hedging as I am a proponent of knowledge of risk. If you are comfortable—or even someone who seeks—assuming risk, then the decision NOT to hedge may be perfectly appropriate for you. However, if you have many other things that require your attention, it may well be worth your while to investigate.

Daniel J. Justin
Regional Sales Manager,
DTN Refined Fuels

The Cautious Hedger
I agree that hedging is a very important tool for most petroleum marketers, and this has become more evident in the past few years. However, I would prefer a more conservative approach to hedging. You see, there is an old adage in hedging that pigs get fat while hogs get slaughtered.

From my experience, the worst thing a newcomer to hedging can do is take an aggressive position on his first trade and do very well on the outcome. The aggressive hedger will be full of a false sense of security that all trades will be like their first, a great success. As a result, he will take an even more aggressive position in the market and end up losing a great deal of money and never hedge again.

With great rewards there are great risks, and many speculators and hedgers who thought they could make big money fast in commodities have actually lost small fortunes.

Recently, there was an account that bought speculative, aggressive instruments, which had paid well over the years. One year, he doubled his spec trade and the market reversed itself and the hedger/speculator lost his job, the company was absorbed by a competitor and his former company lost nearly $1 million from that one trade.

During that same time, another account took a conservative approach to his hedging and would only hedge 10% to 20% of his sales that were not contractually committed over the year. He did well, but not as spectacularly as the more aggressive hedger. His company absorbed the company in the previous story.

Following a conservative approach you will find that you might be hitting quite a few singles, doubles and an occasional triple or home run. However, more ball games are won by the short blooper to the outfield than the towering home run.