Basics of Hedging and Price Protection
First Things First
Determine what risk you are trying to protect against. The simplest question to ask and answer is whether you are hurt if prices go higher (you have agreements to deliver fuel you do not yet own, or you have a fuel budget for the year but have not acquired or set a firm fixed price for the year), or if they go lower (you own fuel you have not yet sold, have fuel in-transit you can’t sell, etc).
Most oil businesses have had the experience of being on the wrong side of price changes. They may have been holding inventory that loses value when prices fall. Sellers of oil may have put off purchases, believing prices would fall, giving them a lower purchase price. Prices may rise instead, imposing the added cost of being wrong.
Hedging is a way to avoid these outcomes. Many oil industry dealers use hedging to establish a price that need not change even when the markets are chaotic and there are uncertain expectations of where prices are going. Learn more at Why Should You Hedge.
Where to Start
POWERHOUSE offers brokerage services, expertise and training in the way hedging works.
Learn the strategies, concepts, practices, and language of hedging. Powerhouse offers through our sister company Powerhouse Structured Products in-person training classes in different geographic regions twice a year. We have also developed custom training delivered on-site for our customers.
Buying and selling hedging contracts can be done on regulated exchanges or through bi-lateral agreements. Powerhouse can help with executing purchases and sales of hedging contracts (futures and options), creating a hedging account, monitoring market conditions and trends, notifying clients of threats and opportunities, and executing trades for our clients.
Each company has its own constraints and opportunities, Powerhouse helps our customers determine the best way to use hedging to manage price risk, and create competitive opportunities to grow their business.
A Bit of Background
Hedging has been around since the 1840’s, when it was used for farm commodities. Hedging is now widely used in energy markets where market moving events like weather, international conflicts, and most recently, cyber-crimes have shown why protection from volatile pricing is so important.
A special language for hedge participants has developed over the years. This simplifies the hedging process. The dealer that owned inventory is long wet, that is, owning the physical inventory. The dealer’s risk is that the value of inventory falls before it can be sold. A hedger could protect against that outcome by being short futures.
The dealer that decided to defer purchase of wet barrels in hopes of lower prices could buy call options. A call is a financial instrument that increases in value as prices rise but loses no more than its original cost. (The complement to the call is a put. The put gains value as prices fall.)
POWERHOUSE is always available to ensure that the financial instrument is correct for the situation. The correct strategy goes a long way toward ensuring a successful hedge.