How to keep your customers and maintain your profits

HEDGE, HEDGE, HEDGE.  There is an aphorism in the academic world that says, “publish or perish” in reference to advancing a career.  Our aphorism is Hedge or Perish.

• Customers want and need some price certainty. Capped prices cost more to hedge (generally in the form of an option premium cost) but provide far more pricing flexibility and customer retention than either Fixed price or Variable price (rack plus) offerings.
• Basis – not just a nice to have. Thanks to many of the factors above, the certainty of a reference point (Merc, New York Harbor, US Gulf, etc.) as compared with your Supplier rack posting seems to have basically disappeared.  “Diffs” that were 10 cents exploded to almost $2 last spring and almost as much this past fall.  There is no perfect way to hedge the basis, but you need to consider:
  1. Fixing a REASONABLE basis with your supplier
  2. Access to storage that is hedged – but is also physical and available
  3. Paper hedges of basis differentials
• Volume
  1. Have your customers – in the aggregate – changed their consumption per HDD?
     1. It is not a hard analysis, but looking at the gallons per HDD juxtaposed to the retail price might give you some insights (and those insights will likely confirm some of those feelings that you have had in your gut)
     2. Are they using heat pumps or other ancillary devices while you are rationalizing the increase in Ks, while waiting for the usage to pick up again
  2. Let’s not forget that the biggest determinant of consumption is not the price, but the temperature. HDD options (weather derivative or HDD puts) need to be considered and assessed.  An important note is that the old adage that “if it is warm outside (lost volume), wholesale prices will fall, and you will keep your retail price higher to offset the lost income” – that adage has way too many holes in it, the most important one being that the correlation between the weather and the price of ULSD and LP is not nearly as strong as you might suspect it to be.

Written by Phil Baratz

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.