Oilheat Marketing...
continued from p.27
(say 20% warmer than an average January—like we
have seen a couple of times lately), and sometimes it
can be much colder—say, 20% colder than average. In
actuality, it is rarely average—and that led us to realize
that “average” and “normal” are not the same thing.
This chart shows the distribution of actual heating
degree-days (HDD) as compared with the 10-year
average for each month over the past 10 years (70 data
points = seven months times 10 years). As you can see,
the actual monthly HDD are all over the place, with
very few actually close to the average.
This chart shows how wide you need to go to truly
capture what would be deemed to be “normal.” As you
can see, 80% of months are between 80% and 120%
of average, whereas 88% of months are more than 5%
higher or 5% lower than the average. In other words,
hedging with “average” volume is almost always going
to leave you with either not enough gallons hedged or
too many gallons hedged.
When you don’t have enough gallons hedged (due to
cold weather), and prices rise (as there is a good correlation
between weather and price), you are likely buying
those needed gallons at a rising price.* On the other
hand, if it is warm and you are “over hedged,” those
gallons are more than likely at a falling price* and you
will have to sell them into the marketplace.
We feel that it is time that dealers look to limit the
volumetric exposure that is inherent, and, as the charts
show, are very regular. By looking to further customize
either swaps or options to match not only the price risk
(strike price or swap/futures price), but also matching
the volume with that actual weather—not the historical
average weather—another layer of uncertainty can be
transferred (hedged) to a trading partner who is willing
to assume that risk.
Think about the months when it got cold and you
simply didn’t have enough hedged gallons to match
your delivery obligations. Or, perhaps even worse, what
about the warm months that leave you sitting with
gallons that, not only don’t you have a need for, but you
also have financial exposure—such as with a fixed price
offering or with gallons in storage.
There is not enough space (and, I prefer that my readers
don’t fall asleep) to go into the details of how to better
hedge volume in addition to price, but the complexities
are not that great and the cost benefits might be
enough to make you wonder why this article hadn’t been
written before. Settling your trades against a predetermined
volume is a very good way to hedge, and given
the way that the industry moves, it may be considered
a very appropriate way to do so. Settling your trades
against something—the actual weather— that more
closely matches up against your deliveries may soon
become the best practice.
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. ICM
*Please note that we are not opining on whether the
weather and price will follow each other. They might and
they might not. There are strong historical correlations,
but our main purpose with this type of trade is simply to
match risk volumes with hedged volumes.
30 ICM/November/December 2017