May 30, 2009 – With oil prices climbing back above $60
US a barrel, aggregate producers and roadbuilders are once again looking at ways
to manage fuel costs. Jim Sanderson of the Jim Sanderson Group explains one
“This method involves entering into 2 to 12 month
future contracts with a financial institution to hedge a fixed volume of
heating oil (highly correlated to diesel and each contract represents 42,000
gallons or 158,970 litres). In Canada, only two banks, Scotiabank and Royal
Bank of Canada,
are licensed to enter into a hedge agreement of this nature with their clients.
Hedging in action
Two strategies for building an effective hedge are
those that lock-in a future price and those that lock-in a maximum (or minimum)
Here is how a lock in strategy would work. A contractor, who anticipates using 320,000
litres of diesel fuel in August and to protect themselves from any rising
prices, purchases 2 NYMEX heating oil futures contracts for September. Later in
August when the fuel is actually purchased, they would sell the futures
contract. If the price of the diesel
were to rise between now and August, the contractor would pay more for fuel on
the road, but will realize an offsetting profit on their futures
transaction. If the price went down over
that time period, the fuel would be purchased at the lower price. The loss on the futures transaction will be
roughly equal to their savings on fuel.
This transaction will protect the hedger against losses resulting from
unanticipated price increases. It also allows you to reassure your clients that
your fuel costs will be consistent for the next 12 months.
important to understand that hedging will not make you money, but will provide
price stability during a time of price volatility.
did not want to lock-in the price of future fuel purchases, but rather wanted
to have protection against an extreme increase in price, you could employ the
second type of hedging strategy and lock in the maximum price you pay for
fuel. This would be similar to buying
insurance. In this hedge by using
options, a contractor can benefit from advantageous changes in prices while protecting
them from losses due to adverse changes.
Energy markets, like other markets, never stand
still and it’s tough to forecast the next policy shift or global event that
will throw everything out of whack again.
Hedging allows you to fix the diesel price for your
company, minimize the volatility and surcharges and lets you get on with your
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