2021 Hedging Survey

Hedgers consider a year like no other and its implications for tomorrow

A pandemic, negative crude oil prices, a recession, increased biofuel adoption on the part of oil refiners (!), and a transition of power in Washington, DC: it’s truly incredible to think that all of this happened in less than one year, yet here we are. In another decade, any one of these topics might have fueled an entire Oil & Energy hedging survey; in April 2021, we address all of them and more! After all, what good is a fuel marketer’s hedging survey that doesn’t also ask about heating oil prices and OPEC?

There’s plenty of food for thought in this article, so we won’t pile any more on your plate with our introduction. For context, however, here are just a few figures pulled from this issue’s Diff. (page 3) and Stats Page (46). On March 8, 2021, the New York Harbor spot prices for No. 2 heating oil and No. 2 ULSD were $1.762 and $1.906 per gallon, $0.613 and $0.724 higher than at this time last year, respectively. As of March 12, the U.S. had 137.7 million barrels of distillate fuel in stock, including 46.3 million on the East Coast, up 12.6 million and 9.8 million from last year, respectively. From July 1, 2020 through March 13, 2021, the U.S. had a population-weighted average of 3,385 heating degree days, 140 more than last year and 283 fewer than normal.

Once again, Oil & Energy asked hedging providers who support the heating fuel market about their thoughts on the current marketplace and prospects for the future. We would like to thank each of the companies that took the time to participate: Aletheia Consulting Group, Angus Finance, Global Partners LP and Hedge Solutions.   

From your view, how has the coronavirus pandemic altered the financial playbooks of heating fuel dealers that utilize hedging as part of their business strategy?

Hedge Solutions: The pandemic has impacted the industry in multiple respects, but the overall result is that it has fared OK in the end. This doesn’t speak to the tragic loss of life and injury to its customers and employees. Strictly from a risk management perspective, it yet again illustrates the importance of hedging. You simply never know what lies around the corner that can profoundly impact prices. Who saw a pandemic coming down the tracks when they were hedging in the summer of 2019? Just when you think your model has every fundamental covered, the unheard of materializes. Does it change the structure of your hedges?

One element, which has always been there and we always discuss with our clients, is basis. The basis (the delta between the spot NYMEX price and your rack or prompt deal) has been significantly below the norm throughout the winter. That means if you bought a wet barrel (with a put option) to hedge your cap program, you left quite a bit of money on the table. Estimating consumption has also been a bit trickier with the work-from-home dynamic playing out.

Global Partners: Hedging has been and will continue to be the main mechanism for mitigating price risk and volatility for fuel dealers and suppliers. The pandemic has highlighted price volatility, and has demonstrated the value in being flexible with committed gallons through fixed contracts and being quick to react when spot opportunities present themselves.  

Angus Finance: I think that this past year we saw a little bit of a heavy lean on wet barrels with puts to implement price caps and saw a lot more activity with “storage hedges” for those who wanted to take advantage of the “cash-to-futures” discount that presented itself in the spring, when it looked like the whole world was falling apart. Dealers who offer pricing programs and hedge should not be changing their minds about hedging or deciding when the “best time” is but should remain on course – as most did.

Aletheia Consulting: The COVID-19 pandemic has made retail energy companies contemplate the risk of buying wet barrels months in advance. For example, a whale watch company locking in their price of fuel months in advance might seem prudent at the time, but what if the local government shuts down the business due to social distancing guidelines? All of a sudden you don’t need that diesel fuel you thought you needed. Is there a reverse force majeure in your wholesale supplier contract to let you out of your commitment? I am not aware of any wetbarrel contract that currently gives recourse to the energy retailer due to pandemics. The wetbarrel terms and conditions need to be updated to reflect the added pandemic risk to the energy retailer.

Heating oil prices started this season down significantly from last winter but steadily climbed over the past few months. How have heating fuel dealers used hedging to profit in the face of these price swings?

Global: As uncertain as the early spring felt with the industry adjusting to the realities of the coronavirus, the general strategy for dealers has been and remains the same as it relates to hedging. A balanced fixed strategy is pivotal in participating in a falling market and protects dealers against a crash. By utilizing fixed pricing offers from Global and/or acquiring downside protection to hedge against market prices creeping higher, dealers can ensure that they remain competitive despite market fluctuations.

Angus: It fully depends on what programs they offered to their customers and how they chose to hedge that risk – both price and volume. If someone “made money” by seeing the market rally in price over the winter, the greatest likelihood is that they were either speculating (something that is fine, but should not be confused with hedging) or misjudged their delivery volumes.

Aletheia: When high-probability hedging is implemented, then dealers can take advantage of favorable pricing. In order to increase the success of a hedging program, you need to take into consideration implied volatility and the underlying price.  Additionally, certain technical indicators (that have been back-tested) can add insight to purchasing decisions.

Hedge: What we call short-window hedging has been very effective in mitigating margin erosion. Heating oil dealers have a really hard time keeping pace with even moderate price increases over, say, a week’s time. This “lag” typically results in a reduction of their profit margins. Hedging lets them lock in a profit margin over a period of days or even weeks, which allows them to “catch up” with price increases over that same period. This is critically important in a seasonal business model like theirs.

The price of oil since November 3 (Election Day) has seen a relentless march higher through the heating season. The price of the ULSD spot contract has settled higher a staggering 64 percent of the trading days between November 3 and March 10 (as of this writing). There have been almost no measurable pullbacks over these four months. That makes it very difficult to maintain your target margin unless you’re hedging!


In 2020 we saw crude oil futures drop below zero for the first time in history. What are the most important implications here for heating fuel dealers?

Angus: As exciting/nerve-wracking as those two days were, ULSD prices never came close to “going negative.” There are several interesting implications for the trading marketplace; however, as it relates to the hedging of future deliveries, those who followed a hedging plan were not really impacted by the “long squeeze” at the expiration of the crude oil contract.    

Hedge: The infamous drop below zero was really just an anomaly. Though I believe the CME made a mistake in not stopping trading at zero, it really didn’t matter unless you were actually holding a crude oil position, say, as a speculator. That rendered a whole host of issues we don’t have time to go into. It probably warrants a slight raise of the eyebrows for the regulators.

Global: The crude oil futures situation taught us that locking in contract pricing for supply without hedging may be a recipe for disaster. For example, the flat price for heating oil in October 2019 looked low compared to historical averages, but as we observed in winter 2020, prices can drop dramatically.

Aletheia: Black swan events occur! That is a fact that no one involved in trading equities or commodities denies. We live in a day and age of unprecedented market volatility, thus companies must hedge their price exposure. Future taxes and regulations can’t be controlled but price risk can.


Is there any reasonable expectation or remote possibility that this could happen to heating oil futures? If not, please explain why. If so, can dealers prepare for and benefit from such outcomes using hedging?

Aletheia: It would be highly unlikely. The WTI delivery point of Cushing, Oklahoma creates a bottleneck for the transportation of crude oil via pipelines. The delivery point for ULSD is New York Harbor, thus allowing for a much more efficient location for delivery.  

Angus: Before it happened, there was no “reasonable expectation” that it could happen, so I wouldn’t want to say that it can’t. However, the move negative did not get reflected in any of the product markets. So, without speculating, I would say that there is a low likelihood of it happening. For it to happen, the situation of not having any available storage in combination with a large availability of physical supply would have to happen. Remote possibility? Anything is possible. Hedging plans around it? Likely not time well spent.

Hedge: Since it happened to the crude oil futures contract, it most certainly could happen to the products futures contracts, like ULSD and RBOB. If trading a CME exchange product like a ULSD contract, it may have posed an issue if you had a short position (hedging a long physical position, for example). However, when it comes down to actually picking up the physical product, it would be almost impossible to go negative. I have not read or seen any indication that the CME has changed its policy or contract structures to prohibit a negative price.

Global: The reasons that led to the inverted price of crude (e.g., little to no refinery demand due to limited storage, historic demand collapse, speculative trading, etc.) are not as likely to occur with respect to heating oil futures. Nevertheless, it is important not to be speculative with your hedge strategy and to maintain flexibility to adjust to market anomalies like negative pricing.

Lately we are seeing more refining companies invest in biofuel production. Heating oil wholesalers are also promoting renewable fuels. With this in mind, how can the biofuel industry’s financial instruments (RIN values, LCFS and AFS credits, biodiesel and feedstock futures, etc.) be incorporated into heating fuel marketers’ hedging strategies?

Hedge: I am certain that there will be opportunities here. Whether it’s in the over-the-counter world of bilateral agreements or through a regulated exchange remains to be seen. There are hedging programs out there now, and there are RINs contracts “trading programs” if you will. We are currently studying all of these and other concepts.

The critical components have to be liquidity and transparency. You need both at the same time, and the markets don’t have that as of yet. But I believe we will as the market moves toward renewables over the next several years. I also believe that hedging will be absolutely critical to the heating oil dealer’s success in the procurement space.

Aletheia: Depending on the fuel marketed and the percentage blended, the renewable fuel can be hedged using various financial instruments. Alternative fuel credits can be monetized, but care must be taken when determining if the added cost of the biofuel offsets the value of the credits.

Angus: The best way to benefit would be to have futures or derivative products that most closely match the risk exposure. So, to me the question is really the opposite – if there are changes in the offing relative to what fuel marketers will be purchasing, how can they best manage that risk?


Several states in the Northeast are actively considering policies that would increase heating oil and diesel fuel costs by implementing carbon pricing mechanisms. Should dealers yet take this into account when formulating their hedging strategies?  

Global: Since the specifics of many of these policies, and the costs related to such policies, are unknown at this time, it is impossible to say whether there should be some sort of hedging strategy in place to address these unknowns.

Aletheia: Although it’s not clear what future carbon taxation will look like, dealers need to evaluate how they currently maximize profit. As with managing an investment portfolio, which can include real estate (physical assets) as well as stocks (paper assets), the energy retailer has the choice of wet barrels (physical) as well as options (paper) to manage their hedging requirements. Although most dealers are quite familiar with wet barrels and online buying platforms, many are not taking advantage of the flexibility and customization that options provide. Heating oil options allow you to manage price protection programs and oil bought daily at the rack.

Angus: It sounds like your question relates to something that is not imbedding into the costing structure of the physical product, but to something akin to a tax. If so, it would seem that (a) the timing will be critical as to when these costs might be introduced, and (b) the incremental cost should be factored into the sales price of the product much in the way that you would factor in storage, basis, or even the cost of adding personal safety equipment for your staff.

Hedge: It’s difficult to say until one actually sees the policy, the mechanism, and the cost. Is the so-called mechanism really just a tax? Likely. This will also most certainly be passed on to the consumer. Depending on the form, however, there may be a hedging equation that emerges. You just can’t speculate from here; you have to wait and see.


Many economists have floated the possibility of a double-dip recession. Is this something that heating fuel dealers should account for in their hedging strategies?

Angus: The questions of demand and of the ability for customers to pay their bills are always significant ones and need to be factored into any operating budget. You would need to run several scenarios (and stress-test them against your cash-flow assumptions and available borrowing base) to see what the potential impacts might be. A simple answer might be to rely more on options purchases than on wet barrels or swaps, however, that type of decision would need a lot more thinking and analyzing before we would recommend it.

Hedge: At the risk of sounding redundant, my response is indeed redundant. This only pronounces the importance of hedging. If there is a recession or another significant downturn in global economics, then the oil price will likely recede. So it doesn’t make sense to take that risk by not hedging your offers with your customers.

Aletheia: The recent pandemic has strained the finances of many people, thus budget cap programs can help spread out the cost of oil over the year, plus give people a chance to pay less for oil should prices fall. Regardless of what happens to the economy, the focus should be on what you can do (putting hedges on) and not on what economists are speculating about. Focus on what you can control.


How do you expect the changing of the guard in Washington to affect the larger energy marketplace, and what are some possible implications for heating fuel pricing?  

Hedge: We have certainly seen a change right out of the gate here. The rejection of the Keystone Pipeline is the most visible example, though I don’t believe it’s had a real physical impact (the pipeline has been in limbo since the Bush administration). It certainly is an indication of where the Biden administration is headed. The push against fossil fuels will accelerate from here.

I think the impact to the heating oil industry is likely further down the road than, say, gasoline is. The electrification of the auto industry is well under way. The displacement of the auto “combustion engine” with batteries will be a game changer. Roughly two thirds of the barrel of crude oil goes toward producing gasoline. That’s a significant reduction in crude oil demand that will certainly trickle down to the ULSD price. The speed and pace of this phenomenon is difficult to predict.

Aletheia: Trillions of dollars of economic aid (i.e., printing money) will lead to inflation. More restrictions on domestic drilling and infrastructure (Keystone Pipeline permit revocation, etc.) will lead to higher prices. If stimulus measures prove to be not enough to move the economic needle then we could see a collapse in oil demand, thus lower prices.

Angus: It is truly impossible to know. Too much of our country has been politicized, and there is a lot of anger and misinformation on both sides of the aisle. We can easily say that a Biden government will be awful for fossil fuels, but after the election and through the aftermath of the inauguration, prices were strong. You can also look at the simple fact that any move away from fossil fuels (i.e., any version of a Green Deal) will add costs to a very fragile economy. Our new administration, as with most in history, has big plans but has to walk slowly, work with the “other side,” and consider the impacts of their decisions. So, we’re not expecting all that much to change in the near term.

Global: Regardless of the party in charge in Washington, it is important that the industry continues to advocate and emphasize the importance of heating oil in order to ensure that millions of Americans are able to heat their homes in times of need. To that end, Global is proud to be part of the Project Carbon Freedom initiative.

Project Carbon Freedom is a coalition of American heating fuel distributors in the Northeast and farmers in the Midwest who support the scientific community’s assessment that advanced liquid biofuels are essential in order to quickly, safely, and affordably transition our country to a carbon-free economy.

Through outreach, education, and advocacy, Project Carbon Freedom aims to advance a commonsense strategy to optimize existing supply chain infrastructures in order to meet state and federal decarbonization targets with domestically produced, renewable biofuels that neither compromise food supply or land use, and which are already being used to heat homes across the Northeast and beyond.


Where and how do international market factors like OPEC+ production cuts and IMO 2020 sulfur limits (and/or others) figure into all of this?

Angus: As of late it seems that the Saudis have taken the lead role in OPEC+ back from the Russians. They are leading with production cuts as necessary and seem to be valuing (as of this moment) stable pricing over market share. Should that remain the case, the questions will relate to returning demand and producers’ ability to “stay the course.”

Global: Policies and actions which affect the international oil markets will always have some bearing on the heating oil market. For example, OPEC production cuts will likely generate a higher heating oil market price. The opposite is true in the case of OPEC production increases, which will likely drive prices down. International impact on the heating oil market has lessened over the last 10 or so years due to an increase in U.S. production; however, OPEC and other international policies and actions should be a factor in the price we see in the immediate and near future.

Aletheia: OPEC+ looks to be carrying over its supply cuts. This could be an attempt to offset the speculation that Iran will potentially add millions of barrels a day to the global markets this year at some point. At the end of the day it all boils down to how quickly we can get back to a restriction-free economy with businesses completely open.

Hedge: Difficult to say. Of course, COVID has and will continue to factor into this equation over the coming months. The pandemic impact on the shipping industry, specifically the cruise ships, has likely mitigated the IMO 2020 impact, though it looked to be assimilating nicely into the marketplace pre-COVID.

OPEC, surprisingly, has managed this crisis well so far. That said, members per usual are getting impatient and looking to bump their limits higher. How long will the Saudis bear the usual burden of production cuts? How long will Russia want to participate? What happens to shale production when crude oil hits $60 plus. These are critical factors that are really difficult to predict with any measure of accuracy, but they will have their say in where the price goes in the near and distant future.


Any parting advice for next heating season? Are you offering any new products or services for 2021?

Global: It is imperative that, as market conditions change, dealers and suppliers continue to have access to a reliable supply of heating oil. Global Partners will continue to be an industry leader and support our customers though advocacy and an enhanced customer experience.

Hedge: Hedge Solutions continues to improve its service to its client base. We have made dramatic improvements to our proprietary management platforms, HedgeInsite and MarginTrak. We will be coming out with an abbreviated app of HedgeInsite before year’s end, which I am really excited about.

Angus:  Our advice is as follows:

Stay the course – don’t jump in because prices “look good,” but try to match hedging against your potential exposure.  

Historical demand might be out the window with working from and learning from home. Watch your projected volumes closely.

Weather hedging is growing in importance.

We have iPhones, “Alexas,” and have an app to deliver everything that we want from Amazon to our front doors. Yet, most companies run their operations with the same focus on technology (or lack thereof) that they had 20 years ago. There are MANY tools that provide almost immediate return. If you are not using them, you can be assured that your competitors are starting to!

Aletheia: My parting advice would be to learn how to incorporate option trading in your business. Option trading allows you to maximize your margin by giving you the flexibility to buy the physical oil from whomever you want when you want. In this post-pandemic economy, timing is of utter importance. Option trading allows you to adjust positions quickly due to changing market prices. Aletheia provides options and futures trading, consulting and renewable energy credits monetization.


Disclaimers

Aletheia Consulting: Aletheia is registered with the National Futures Association as a commodity trading advisory and swap firm.PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. The risk of loss in trading commodity interests can be substantial. You should therefore carefully consider whether such trading is suitable for you in light of your financial condition. In considering whether to trade or authorize someone else to trade for you, you should be aware that you could lose all of your investment and be liable for amounts above your initial investment.

Aletheia Consulting Group LLC does not guarantee or warrant that the contents contained herein are 100% accurate. We have made reasonable effort to present accurate information, pricing, and statistics. Therefore, the information is provided “as is” without warranties of any kind.

In no event shall Aletheia Consulting Group LLC and its related principals, agents or employees be liable for any damages whatsoever, arising out of or in connection with website, information, or other verbal and written communications.

Information contained herein was obtained from sources believed to be reliable or is a reasonable assessment of that information, but is not guaranteed as to its accuracy.    

Angus Finance: PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. The risk of loss in trading commodity interests can be substantial.  You should therefore carefully consider whether such trading is suitable for you in light of your financial condition. In considering whether to trade or to authorize someone else to trade for you, you should be aware that you could lose all or substantially all of your investment and may be liable for amounts well above your initial investment.

Global Partners: The opinions expressed herein are for general informational purposes only and are not intended to provide specific advice or recommendations. Trading commodity interests involves substantial risk of loss and is not suitable for every situation or financial condition. You must assess the risk of any trade or product and make your own independent decisions. Past performance is no guarantee of future results.

Hedge Solutions: The information provided in this market update is general market commentary provided solely for educational and informational purposes. The information was obtained from sources believed to be reliable, but we do not guarantee its accuracy. No statement within the update should be construed as a recommendation, solicitation or offer to buy or sell any futures or options on futures or to otherwise provide investment advice. Any use of the information provided in this update is at your own risk.

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