Guidebook for Evaluating Fuel Purchasing Strategies for Public Transit Agencies (2012) / Chapter Skim
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Pages 10-22
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From page 10... ...
10 Hedging with Forward-Price Instruments The most common instrument for fuel price hedging is the forward-price instrument, commonly called a forward contract. Forward contracts allow consumers to lock-in the price of a specific volume of fuel that will be consumed in the future.
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Hedging with Forward-Price instruments 11 (a cash outflow)
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12 Guidebook for evaluating Fuel Purchasing Strategies for Public transit Agencies will be replaced with ultra low sulfur diesel (ULSD) as NYMEX responds to environmental regulations in New York State requiring lower sulfur standards for heating oil.4 Gasoline is typically hedged with futures contracts tied to reformulated blendstock for oxygenate blending (RBOB)
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Hedging with Forward-Price instruments 13 tracts are traded for 36 consecutive forward months.6 For both products, contracts that cover near months (one to six months forward) are more heavily traded -- and thus more liquid -- than contracts covering further out months.
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14 Guidebook for evaluating Fuel Purchasing Strategies for Public transit Agencies Transit agencies can hedge using futures contracts by making an arrangement with a futures broker who has a seat on the NYMEX. When buying or selling futures contracts on NYMEX, the transit agency must post collateral in the form of a margin account (also known as a performance bond)
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Hedging with Forward-Price instruments 15 9"The Basics of Basis Risk." Mercatus Energy Pipeline. Mercatus Energy Advisors.
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16 Guidebook for evaluating Fuel Purchasing Strategies for Public transit Agencies Basis Risk, Cont'd. Region Definitions: http://www.eia.doe.gov/oog/info/twip/padddef.html Source: SAIC, Energy Information Administration: http://www.eia.doe.gov/dnav/pet/pet_pri_dist_dcu_nus_m.htm and http://www.eia.doe.gov/dnav/pet/hist/LeafHandler.ashx?
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Hedging with Forward-Price instruments 17 11"Gulf Coast ULSD (Platts) Up-Down Spread Swap Futures." CME Group Website.
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18 Guidebook for evaluating Fuel Purchasing Strategies for Public transit Agencies 3.1.3 Summary Futures contracts can be an effective, low-cost way to hedge fuel prices for gasoline and diesel fuel use. These products are easy to understand, relatively inexpensive to arrange, and hold very little counterparty risk because they are arranged through NYMEX.
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Hedging with Forward-Price instruments 19 3.2.1 Advantages OTC swaps hold two advantages over futures contracts. The first is that OTC swaps can use a local pricing index instead of NYMEX, thus eliminating or reducing adverse basis risk for the fuel buyer.
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20 Guidebook for evaluating Fuel Purchasing Strategies for Public transit Agencies OTC swaps are also subject to the risk that the swap counterparty will go bankrupt and default on its end of the obligation (or choose to strategically default on its obligation)
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Hedging with Forward-Price instruments 21 retail business model: suppliers buy fuel from refiners or importers and then resell the fuel to buyers (such as transit agencies) with a markup to account for delivery costs and profits.
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22 Guidebook for evaluating Fuel Purchasing Strategies for Public transit Agencies and mid-sized cities, competition in the fuel procurement process could be reduced. Furthermore, fuel suppliers in smaller markets may not offer FFP services, or may require an exorbitant premium in order to start a fuel hedging program and offer a fixed price.
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