Forecasts for this hurricane season to be one of the busiest ever are showing early signs of accuracy. Tropical storm Alex became our first North Atlantic basin storm yesterday and is rapidly heading for the Yucatan. Several other tropical disturbances are forming off the coast of Africa and Eastern Caribbean. Is it too late to be prepared for potential price spikes on gas and diesel?
Fuel buyers are often hesitant to raise their immediate fuel costs by enacting a futures or derivatives hedging strategy. What needs to be understood is that these minor costs are lowering the risk of major losses should severe supply disruptions occur during the hurricane season.
On Friday RBOB and distillate futures jumped .055 and .075 on short sellers buying back their positions, not willing to risk major losses should Alex become a major hurricane and steering a path North. Back month contracts were also moving higher on hedgers buying futures and options contracts enabling them to add to profit margins should the products continue moving higher.
A solid hedging strategy in preparation of hurricane induced higher gas and diesel prices is to simply by fixed forward contracts and minimizing the price fluctuation risk by buying put option contracts. Of course timing is everything. Fixed forward contracts need to be locked in when prices are falling and put options need to be purchased when premiums are least expensive which occurs when futures are rising.
The difficulty in enacting the above hedging strategy is that it is against human nature to lock in a fixed price when prices appear to want to keep going lower. Using technical analysis to determine monthly support and resistance levels helps overcome the natural resistance to lock in on a down trend, giving the fuel buyer confidence the right decision is being made. Just as difficult is not paying too much for option premiums and waiting for an uptrend to begin before purchasing the put options.
Many fuel buyers and even some producers of refined products, steer away from any hedging strategy thinking it is too costly and administratively difficult to monitor. The extra time, effort, and expense actually gives great price and supply risk protection enabling a distributor to continue operating cost effectively during supply disruptions, when competitors are selling at a loss.
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