Traders and brokers report the busiest spell of consumer hedging in years as more companies hedge against the continuous oil price spike. Fuel-heavy companies fear that this could paralyze them. Energy costs are fueling the world’s fastest inflation in years.
If your company is vulnerable to fluctuations in energy prices, fuel hedging is a tool that can help reduce the risk of your fuel budget spiraling out of control. As the war drags on and supply-demand imbalances worsen, you would want to protect against higher prices in the future.
Fuel hedging, also known as fuel risk management, is a strategy used by some businesses to reduce or eliminate vulnerability to volatile and potentially rising fuel prices. It’s a contractual tool that lets a company cap or fixes fuel prices for a certain time. Diesel, gasoline, jet fuel, and other refined products can be hedged.
Reasons for Hedging Gasoline Prices
Fuel hedging can protect companies whose fuel costs make up a large portion of their operational costs from unexpected price changes that could hurt their budgets and profit margins. By fixing your fuel costs, you can avoid budget overruns caused by a volatile oil market. Mitigating market volatility protects budgets, improves cash flow, and stabilizes prices.
How Does Fuel Hedging Work?
A fuel buyer establishes a market position by purchasing a futures contract—a standardized agreement between two parties to buy or sell a specific commodity for a quantity and price agreed upon at the time of the transaction, with delivery and payment taking place at a specific date in the future. For that time period, the consumer is obligated to purchase the good at the agreed-upon price. In a similar vein, the supplier is required to sell the good at that cost.
By transferring the risk to a party with the opposite risk profile, such as a natural gas producer, or to traders who are willing to accept the risk in exchange for potential profit opportunities, hedging lowers a company’s exposure to natural gas price risk. Establishing a position in a financial instrument that, ideally, is very similar to, if not identical to, the company’s exposure in the physical natural gas market is the general process for natural gas hedging. The “market” where a company purchases the actual natural gas it needs for daily operations is referred to as the physical market, also known as the cash or spot market.
Fixed-Priced Program Benefits
You must balance reward and risk. Money can be saved, but it can also be lost. While you might miss the lowest fuel prices, you might also be able to avoid any potential increases in fuel prices. With fuel hedging, you accept that risk. Lack of a contract, however, entails risks because fuel prices can and frequently do change overnight.
If prices fluctuate downward rather than upward, you might be disappointed, but you have not lost. Your overhead expenses stay within budget parameters, and your business continues to turn a profit. In this instance, the stability justifies forgoing the additional savings.
A business or fleet manager can feel secure despite the unpredictability of fuel prices thanks to the guarantee that comes with using hedging as a risk management tool. And you are free to benefit from the lower prices once the hedging contract period has ended.
It’s crucial to keep in mind that hedging should not be considered a way to make money but rather a way to help reduce risks and relieve the stress associated with trying to predict fuel prices.
Who Needs Fuel Hedging?
Companies were forced to implement fuel cost reduction programs to combat price volatility, such as downsizing to four-cylinder vehicles, restricting personal use of company vehicles, and holding online meetings instead of traveling off-site, when fuel prices were at their highest.
These are all helpful solutions, but the volatility of fuel prices cannot be overlooked. Your company’s efficiency should not be dependent on global events, natural disasters, or other factors that affect the price of oil.
Fuel hedging is a good option for businesses that prefer to plan for the unknown and plan properly. Having a fixed fuel price that is not affected by market fluctuations can help with things like keeping equipment in service, reducing layoffs, and realizing profits for owners and shareholders.
When deciding if fuel hedging is right for your fleet, you must consider fleet size, oil price tolerance, and current and future financial goals. Not alone. Let experts help you control energy costs for months or years.
Futures Hedging Options
A futures contract is a standardized agreement between two parties to buy or sell a specific quantity and quality of a commodity at an agreed-upon price for future payment. Trucking companies would “go long” on ULSD futures to hedge against rising fuel prices (s). If fuel prices rise, its fuel costs will rise, but its long position will offset that. If fuel prices drop, the consumer’s net fuel cost is the retail price plus the futures loss.
Options are insurance. An option gives the buyer the right, but not the obligation, to buy or sell futures contracts at a set price. Call options protect buyers from rising prices. Put options protect buyers from falling prices. Unlike futures or swaps, a call option buyer has a hedged position, but if fuel prices drop, they only lose the option premium. And this is an ideal strategy.
A swap is an agreement in which one party (i.e. trucking carrier) exchanges exposure to a floating fuel price for a fixed fuel price over a specified period(s). A swap guarantees the fuel user’s future purchase price. If the price drops, the fuel user will pay much more for fuel due to swap losses. Many fuel hedgers prefer swaps over futures because they are a better hedging tool, as most fuel swaps settle against the monthly average price vs. day.
Other Fuel-Hedging Strategies
Other fuel price hedging strategies include futures, options, and collars. A collar hedge uses multiple call and put options to protect against rising fuel prices and limit losses. Fuel collar hedges include three- and four-way collars.
How Credo CFO Services Can Help You
Fuel hedging is an efficient strategy to mitigate the risk of volatility; however, it cannot be used as a speculation means to generate profits. The combination of financial and operational hedging can be used for gaining/maintaining a competitive advantage and enables companies to achieve sustained financial performance.
Credo CFO team has a strategic way of mitigating market volatility that would protect your budget, improve your cash flow, and stabilize your prices.
There are two important premises that must be in place to make this work:
– You have enough capital to offset your freight cost variances.
– Negotiate with your vendors freight prices since they are passing on fuel costs to you.
– Our ultimate goal is to absorb freight costs at more than 0.6% of revenues.
Using Credo’s strategy, we are able to…
– Generate a positive variance in freight costs in order to offset your negative variance
– Add back a substantial amount of net income by adding a certain amount into the hedging tool depending on the pattern that you are currently operating under
– Maintain your net profit margins regardless of how freight costs fluctuate
Despite the unpredictability of fuel prices, you can remain confident due to the assurance that comes with using hedging as a risk management tool. Proper development and implementation are keys to creating a successful and ongoing freight management solution to lower overall freight and offer greater control over operating budgets.
Our team at Credo will help you analyze your current freight needs and develop a proactive budget protection strategy with flexible risk management solutions. We will also evaluate your situation as new hedging opportunities arise and anticipate your company’s changing needs.
- Fee Title Acquisition vs. Conservation Easements? Choose Your Conservation Approach Wisely! - May 13, 2023
- Fee Simple Land Donations vs. Conservation Easement Donations: Preserving Wealth and Enjoying Tax Benefits - May 13, 2023
- SVB’s Collapse and the Changing CFO’s Ability to Adapt to Adverse Conditions - March 18, 2023