Destwin, Price Protection, and Hedging
Photo courtesy of Enterprise Equipment
Many fuel dealers provide fuel purchase plans of various types for their customers. These include budget plans that distribute the cost of heating a home equally throughout the year, and price protection plans that protect consumers from sudden changes in the market price of fuel. Price protection plans usually allow consumers to purchase fuel at a fixed or capped price for some period of time, and may also be for the purchase of a specific quantity of fuel. In order to provide fuel at predictable prices over an entire heating season, fuel dealers must implement a fuel purchase strategy that allows them to deliver fuel to the customer at the agreed price while maintaining an adequate margin to continue operating their business at a profit. This requires that dealers either pre-buy fuel, or purchase fuel futures, or implement a hedging plan to counteract variations in the wholesale price of fuel. Customers Demand Price ProtectionWhy should a fuel dealer offer fuel purchase plans, and not just charge customers based on the current price of fuel at the rack ? The simple answer is that many customers want a stable price for fuel over the course of a heating season, allowing them to budget funds appropriately to meet their needs. Most fuel dealers operate in a competitive environment, and if the competition provides fuel purchase plans, it will be necessary for the dealer to do likewise to remain competitive. Consumers want the ability to lock in fuel prices so that their heating bills are predictable and manageable. Individual consumers do not purchase large enough volumes of fuel to allow them to do this directly. The fuel dealer can combine the purchases from all his customers and implement an effective hedging strategy. This is actually a value-added service that the dealer provides, and he can charge a reasonable fee for this service. Note that the dealer is not making a profit by speculating in the commodities market. He must implement a conservative, risk-free hedging strategy that protects his customers interests. He is simply charging a small fee for the administrative costs of managing many small fuel accounts, and combining them into a unified hedging strategy. Why Should I Hedge ?Hedging is a financial strategy used to reduce risk in a business in which the cost or price of some component of the business can vary due to market conditions. For example, in the heating oil business, the fuel dealer adds value to heating oil by delivering it to the customer's home, and providing installation and maintenance services for the customer's equipment. In general, the fuel dealer is not operating his business to make a profit by speculating on variations in the market price of oil. Yet variations in the market price of oil can cause dramatic changes in the costs of supplying customers with oil. In order to prevent changes in the price of fuel from affecting the profitability of the core business of delivering fuel to customers, a fuel dealer should implement a hedging strategy so that the actual cost of fuel is a predictable value. Note that although the term "hedge fund" is used to describe certain types of financial investments which may be quite risky, the practice of "hedging" is intended to minimize risk due to fluctations in market prices, and implementation of an appropriate hedging strategy can accomplish this very effectively. Hedging is not a way for the fuel dealer to profit from variations in the market price of fuel, but an effective tool to minimize the effect of market variations on the net revenue generated from the core business of delivering fuel. Third Party Risk ManagementFuel dealers are experts at delivering fuel, maintaining tank trucks, servicing heating equipment, and the many other skills needed to allow their customers to heat their homes and businesses safely and efficiently. Fuel dealers are not usually experts in commodity trading, and it may be in their best interest to work with an outside risk-management firm that specializes in the energy markets. In order for this to be effective, the dealer needs to be able to supply detailed information about their delivery requirements and fuel purchases to the management firm. The more timely and complete the information supplied to the risk management firm, the more effective the hedging strategy will be. Requirements for HedgingThe effectiveness of your hedging strategy is dependent upon the availablility of complete and timely information of the delivery commitments to be hedged, and rapid placement of hedges to avoid changes in market price between the time the delivery commitment is made, and the hedge executed. Due to rapid fluctations in the price of fuel, hedge contracts must be placed as rapidly as possible after a consumer executes a delivery contract. To accomplish this, all the data about delivery contracts from customers, and purchase contracts to wholesalers, must be organized and readily available from one source. The data must be organized so the it can be used effectively, whether you manage your own hedging strategy, or contract an outside risk-management firm to do your hedging. Up-to-date, accurate, and complete information is necessary to implement an effective hedging strategy. DESTWIN Supports Your Hedging StrategyDestwin supports hedging of your fuel contracts by collecting all the information needed to implement an effective hedging strategy and organizing it into up-to-date reports that can be used internally by you, or by an outside risk management firm that is implementing a hedging strategy for you. DESTWIN's online fuel contract capability means that data from customer contract signups is captured immediately and made available in real-time to allow futures to by purchased and hedges placed in as short a time as possible. Since an effective hedging strategy requires that wholesale purchase contracts and hedges be placed as soon as possible after a customer executes a contract, DESTWIN's ability to provide up-to-date information is essential for implementing a truly effective hedging strategy. ReportsThe DESTWIN Fuel Dealer Solution produces the necessary reports to allow implementation of an effective hedging strategy. Timely reports including information about committed sales based on executed delivery contracts, and the corresponding fuel purchases and futures contracts, are available online. These reports are available to you for implementing your own hedging strategy, or can be provided to an outside risk manager either online, as a downloadable file, or via email. The DESTWIN Fuel Dealer Solution may be configured to track Calls, Puts, Options, and the other elements of your hedging strategy. In this case, DESTWIN will generate reports relating your hedging activity to your delivery commitments and wholesale purchase contracts. Typical Reports Include the following:
The DESTWIN Fuel Dealer Solution can be configured to provide custom reports to meet the specific requirements of your business or your outside risk manager. Contact us to learn more about the options available. READ MORE --> |