Commentary: To Hedge or not to Hedge

June 10, 2015


With fuel prices being as low as they have recently been, this question has crossed most managers’ minds at least once. Any company that is a large consumer of diesel has likely looked at the declining fuel prices since the fourth quarter of 2014 and danced a little jig. Any consumer that wasn’t locked into a fixed price that is. So who is right: the Hedger or the Floater?

If you look only at October – December of 2014 then you would say the Floater. But what about the future? Should you sit back and allow your fuel expense to whipsaw or lock it in? If you choose to be a Floater then you may find yourself sitting in front of a blank budget document, furiously shaking a Magic 8™ ball hoping and praying for a sign…. Will fuel prices stay flat, fall, or rise? When it comes to budgets, the Hedger’s decision is easier because they have the price locked in; or at least they do for the next 12 to 18 months. Interesting that both strategies put you in the same boat when it comes to a multiyear budget. Both are staring at the budgets, looking for a sign, and thinking, I really wish this was easier!

When considering the above, there several takeaways: #1) We should all buy stock in Magic 8 balls (You have no idea how much they are used around budget time); #2) It is challenging to set a budget for a company or division that consumes significant quantities of fuel; and #3) Regardless of the strategy chosen, there will be times when you are seen as a HERO, and other times - a ZERO. All contingent on where the price of diesel is that day. Not to mention that neither strategy fully covers you for a multiyear budget.

So, is there an answer that solves this dilemma completely? Unfortunately no, we don’t have a solution for diesel. The truth is that the market for diesel futures markets just doesn’t have enough liquidity to hedge beyond 18 months, and even if you had the capacity to store several years’ of diesel, the physical product starts to break down over time. Sure, if money was no object you could piece together a strategy, but we are all in the business of making money; not seeing how long we can hedge fuel. If there was only a way to have our cake and eat it too.

What if there was a viable option? You may think that this contradicts our recent conclusion. But before you scoff, notice that we said there wasn’t the option with diesel. So what are the options if diesel isn’t one? What about natural gas?

Natural gas (compressed or liquid) is a viable option in this situation. Natural gas futures trade over 5 years out with good liquidity, so locking in multiple years isn’t difficult or expensive. Even without hedging and just buying retail natural gas, the pricing swings are far less volatile than diesel. To illustrate this let’s look at the historic prices of both.

Avg retail fuel prices

The nearby graph illustrates that CNG pricing has remained relatively flat for many years while diesel pricing is all over the place. Why is that?

We could talk for days about all of the reasons for the volatility swings, but instead let’s focus on a couple of the major factors. 1) The commodity price of natural gas makes up 25 – 30% of the retail price of CNG while the crude commodity price of is 65 - 75% of the retail diesel price. This means that a spike in crude prices is felt far more than a spike in Natural gas at the retail pump. 2) Natural gas in the United States comes from North America, so it’s not a global market like crude is. This means that far fewer factors, such as geopolitical turmoil, play into the volatility and pricing of CNG and allow the street price to stay relatively stable.

So let’s do a quick recap: natural gas can be hedged for a longer period of time, is historically cheaper, and experiences far less volatility than diesel. So when you consider the original question of to hedge or not to hedge, switching to natural gas can greatly simplify the decision.

 

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About Mansfield Energy Corp:

For 60 years, Mansfield has been creatively solving commercial, industrial, and municipal customers’ most demanding energy procurement, supply, and logistics challenges. Today, the company provides energy commodities and related services to 6,000 customers in 18,000 locations across the U.S. and Canada. The company’s expertise covers a broad range of transportation and facilities energy from traditional petroleum products, CNG, renewable fuels, and specialty chemicals to power and natural gas. Mansfield employees are committed to their customers’ success, abiding by five core principles - Integrity, Excellence, Conscientiousness, Innovation, and Personal Service. The company is headquartered in Gainesville, GA (just north of Atlanta) with regional operations centers located in Chicago, Dallas, Denver, Houston, Los Angeles, Minneapolis, Bloomington, MN, and Calgary, Alberta Canada.

For more information about Mansfield, call 800-695-6626, or visit our website at http://mansfield.energy.