Spring 2018, Vol. 1
- SPRING 2018
DOES YOUR HEDGE MATCH YOUR RISK?
WRITTEN BY: PHIL BARATZ
It’s widely known, and correctly so, that 3 factors have the greatest impact on Customer Loyalty (aka: Retention): Budget Plans, Service Contracts, and Pricing Plans. The primary reason these drive such strong customer loyalty is they all address the innate desire to be cared for.
- Budget Plans avoid big winter bills – who wants a $600 bill due all at once when they can pay under $200 per month?
- Service Contracts are the ultimate in surprise avoidance. While a service contract doesn’t eliminate potential service issues, homeowners can sleep well knowing their dealers will take care of them – and are under contract to keep their equipment running.
- Pricing programs (more for caps than fixed) are proven to keep customers loyal for the same reason – the piece of mind that it brings in knowing that their prices will not rise above a certain level, regardless of the cost of fuel on a wholesale level.
For a fuel company to achieve the expected benefits of offering pricing programs and also maintain predictable profits (in addition to customer loyalty), dealers should put a hedge in place. These hedges (a concept not new to those reading this article) require the dealer to protect a certain number of gallons at a particular price. The combination of volume and price will determine the success of any pricing program.
Most dealers use historical volumes (for either weather or deliveries) to set their winter hedges – i.e. 7%, 11%, 18%, 22%, 20%, 16%, 6% for October through April. This method follows the basic principle that October and November consumption-based deliveries will be less than those in December and January, therefore by creating hedges with “normal” historical distributions, hedge volumes will closely match the needs. However, there are often intra-winter swings in consumption – caused by the weather – that need to be looked at more closely. For example, this past winter was “average” for total HDDs but was far from normal. From October through March, cumulative HDDs at New York’s LaGuardia Airport (LGA) weather station matched the 10-year average (within 1%). However, with deliveries that are spread out over the course of the winter, you need to look at months, not only an entire season.
The chart below displays the 10-year average for LGA HDDs over the Oct-Mar time period in blue, and the HDDs for THIS winter in red.
This winter, beginning in October, went like this:
ANGUS EDUCATIONAL SERIES
WEBINAR REPLAY: DECEMBER/JANUARY COLD SNAP: CRISIS & OPPORTUNITY
PRESENTED BY: DANNY SILVERMAN
As you know, this past winter presented some real challenges for heating oil dealers. Due to the popular demand of the webinar we hosted last month, we have decided to launch a webinar replay! This means that you can now have access to some of our tips on how you can turn extreme weather crisis into opportunity, at any time.
NEW CLIENTS –
WELCOME TO ANGUS ENERGY
Aero Energy, New Oxford, PA
Bourne’s Energy, Morrisville, VT
Dieter Bros, Bethlehem, PA
E&V Energy Corp., Wolcott, NY
Hometown Comfort, New Paris, OH
Leaf River Ag, Wadena, MN
Medford Oil, Medford, NJ
Parkside Fuel, Mount Sinai, NY
If you are interested in any of our solutions to make your business run more efficiently, effectively, and profitably contact us today.
*Blue represents the states of our new clients. Green represents the states of our existing clients.
How did that impact deliveries for this winter?
A hedge of 1 million gallons would normally have covered 220,000 gallons (20%) in January, but the cold weather drove the need for gallons to be even higher. The 200,000 gallons covered for the month of February (20%) turned out to be many more gallons than the weather demanded. There is nothing new about this hedging imperfection, but aside from spending a lot of money to over-hedge, we wanted to see if there is a way to match future needs – needs that are unpredictable – with future hedges.
Are weather hedges a solution?
Many companies are familiar with one type of weather hedging, generally as a very smart way to avoid the pains that a warm winter can bring. Purchasing put options on the weather (e.g., on the number of HDDs) – be they monthly or seasonally – can do a great job in mitigating the damage caused by gallons that are simply not sold. In general, only a small portion of a distributor’s overhead is variable, with most costs – salaries, equipment, drivers, marketing staff, etc. – being fixed. While a cold winter can yield “bonus profits”, a warm winter can have a very different impact. We have seen studies that indicate the first 85%-90% of all sales (all HDDs) are needed just to break even. The “last” 10%-15% are where all the profits are. If the last 10%-15% doesn’t show up – like the past two winters – it becomes increasingly difficult to achieve profitability. So, seasonal puts just make sense to replace a portion of resulting lost profitability in a warmer than normal period.
If you look at a winter that in the aggregate was normal/average, and you don’t have “lost gallons”, you can still find yourself in a poor position if your monthly hedge volumes for pricing programs do not match the demand-based need. As an example, the “extra” gallons that were needed in both December and January.
A new hedge to affordably address this?
To address that exposure – one that is very common – we tasked our analysts to seek out a trading structure that:
- More closely matches the volumetric needs of the hedging – monthly
- Settles every day, as the price of oil changes daily and monthly average prices don’t offer the same coverage as daily-settled trades, and
- With the added caveat that the flexibility doesn’t break the bank
We believe we have identified the trade that accomplishes all three and provides dealers with better peace of mind they want to give to their customers. By factoring in that sometimes dealers need more than, and sometimes less than, “average” gallons protected, this trade – call it a “backfill call” (although some want to call it a “backPhil call”) – does just that. It uses actual weather to determine volume, not assumed volume. In order to make the trade work to give needed volumetric protection, AND to make it affordable, the trade will settle off of volumes determined by the weather but will have a ceiling as to the volume (in this case 110%).
This, backfill call would work something like this:
For the month of November, you would buy a call option with a base volume – using our example, 110,000 gallons. When the month is done, there is a comparison between the actual weather and the historical weather. In our case, the weather was 5.24% colder, so the volume for the trade would increase up to 115,764 (110,000 * 1.06), and the trades would settle against the needed volumes for that month. It should be noted that March’s 15% colder weather would be limited to 10% extra volume so that March trade would settle against 176,000 gallons (16,000 more than would normally be covered). In these cases, where the weather is colder than normal over the course of the month – regardless of the overall winter – the extra gallons would be in place to stand behind the price cap offered to your customers, without having the risk of having those gallons being unhedged.
In the warm month of February – when deliveries were notably lower than a normal February – the trade would settle against the true weather (24% warmer). So, February’s volume for trade settlement would be for 152,000 gallons. The idea of the trade is to better match the actual needs with the hedge.
So, if it’s cold, you get more gallons to match your needs and when it’s warm you get fewer gallons, to match your needs. Sounds perfect, but what is the cost? That is the beauty of the structuring of this trade. The cost is exactly the same as if you were to simply buy the “normal” hedge, with the added benefits of a significantly better match of hedge to risk.
There’s no free lunch, so what’s the catch? Good question. Since the “upside” volume is limited to 110%, and the “downside” volume is not limited, in a warm winter you may have fewer gallons hedged than the “extra” gallons in a cold winter. However, and this is what we like about it, we are not trying to find a trade that maximizes volume – but a trade that better matches volume! If it is warm outside, and the demand for your gallons is not there, why have gallons hedged/settling? However, for the months when it is colder than usual, how valuable would it be to have extra gallons protected – without paying extra!
Want to find out more about the backfill trade? Contact us to get more information
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.
HYPOTHETICAL PERFORMANCE RESULTS HAVE MANY INHERENT LIMITATIONS, SOME OF WHICH ARE DESCRIBED BELOW. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN. IN FACT, THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE RESULTS AND THE ACTUAL RESULTS SUBSEQUENTLY ACHIEVED BY ANY PARTICULAR TRADING PROGRAM.
ONE OF THE LIMITATIONS OF HYPOTHETICAL PERFORMANCE RESULTS IS THAT THEY ARE GENERALLY PREPARED WITH THE BENEFIT OF HINDSIGHT. IN ADDITION, HYPOTHETICAL TRADING DOES NOT INVOLVE FINANCIAL RISK, AND NO HYPOTHETICAL TRADING RECORD CAN COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK IN ACTUAL TRADING. FOR EXAMPLE, THE ABILITY TO WITHSTAND LOSSES OR TO ADHERE TO A PARTICULAR TRADING PROGRAM IN SPITE OF TRADING LOSSES ARE MATERIAL POINTS WHICH CAN ALSO ADVERSELY AFFECT ACTUAL TRADING RESULTS. THERE ARE NUMEROUS OTHER FACTORS RELATED TO THE MARKETS IN GENERAL OR TO THE IMPLEMENTATION OF ANY SPECIFIC TRADING PROGRAM WHICH CANNOT BE FULLY ACCOUNTED FOR IN THE PREPARATION OF HYPOTHETICAL PERFORMANCE RESULTS AND ALL OF WHICH CAN ADVERSELY AFFECT ACTUAL TRADING RESULTS.
Winter 2018 Newsletter Survey Results:
In our Winter 2018 Newsletter, we talked about making mid-season adjustments and surveyed our readers with five questions specific to certain pain points that we have found dealers to feel mid-season. Check out the results below by clicking on the + and see how your company stacks up against other dealers:
Which answer would best describe your company as it relates to fuel delivery efficiency?
|I deliver my accounts according to the projections calculated by my back-office-system and trust that the results will be close to forecasted.||65.00%
|I review my back-office-system projections and make minor adjustments for the weather and for the resources I have available at the time.||21.00%
|I closely monitor delivery settings and exceptions within my back-office systems, continuously make adjustments to projections for next deliveries, watch and use my monitored tanks for accurate deliveries and pay special attention to any outliers that represent my greatest risk.||14.00%
Which answer would best describe your company as it relates to the fall cold snap?
|When the first cold snap hits I implement an all-hands-on-deck policy until the surge subsides||45.00%
|When the upcoming cold snap is announced, I then make plans for proper staffing and rearrange my priorities in order to accommodate the influx of orders, based on past experiences.||43.00%
|By the time I hear about the encroaching cold snap, I have already identified my previously poor performing customers, their tanks and equipment and have made whatever corrections were necessary to bring them in line.||12.00%
Which answer would best describe your company as it relates to customer gains?
|I currently do not track how a customer has heard about our company.||40.00%
|I know that I have codes set up in the system for my customer service representatives to use but they generally elect to use the same few codes.||55.00%
|I have set up gain and loss reasons in my system aligned with other related processes within the company and have trained my customer service staff on the importance of this activity, as I monitor it closely.||5.00%
Which answer would best describe your company as it relates to extended gross margin goals?
|I do all of my supply tracking and costing outside of my back-office system and therefore cannot monitor my margins at the detail level.||39.00%
|Although I input my liquid product receipts into my back-office system for inventory and accounts payable purposes, I do not depend on my back-office systems margin calculations due to external variables that are introduced through my executed hedge positions.||50.00%
|I produce accurate margins for all of my classes of trade within each price program and monitor them daily for any unexpected variance from that which I expect to see at those levels.||11.00%
Which answer would best describe your company as it relates to contract customers?
|I do track my service contract revenues but do not monitor my costs of performing service other than month end.||50.00%
|I track my contract service revenues by plan type but do not accurately monitor an individual customer’s service profitability within their contract year.||32.00%
|I have very tight service inventory controls in place along with labor rates, both contributing to overall accurate costs for margin calculations down to the customer and service transaction level, allowing me to create identify any non-performers.||18.00%
So, how did you do? Interested in learning about how you can stay ahead of these pain points during any weather event? Contact us today at email@example.com.
MEANINGFUL METRICS: Calculating Saved Deliveries
Written by: Bob Levins
One of the most important numbers used in the calculation of an automatic customer’s next delivery is their ideal drop, assigned to their tank/equipment record. This is sometimes referred to as optimal drop. It is a number that is designed to represent a safe target of delivered volume from which to forecast the next delivery, while at the same time avoiding any risk of a run out. Although our goal is to actually arrive at these targeted results, it has been statistically proven numerous times that many deliveries will fall short. BRITE® produces a report that is designed to expose these inefficient deliveries over time, by customer, reflected in a measurement labeled “potential saved deliveries”. This is the “Delivery Efficiency Report”, located as a link on the front of the Delivery Performance widget. The objective of the report is to compare the actual volumes delivered to customer tanks vs. the ideal drop values assigned to the tank records in the back-office system. With these values, we can then determine the missed gallons with each delivery, should they be less than expected. We also know that not every customer has the same burning rate and will use the reserve at different rates, potentially warranting tailored ideal drop maintenance, not the one-size-fits-all approach adopted by many, but that is not for this discussion. The report gathers all the deliveries by customer within a specified date range, calculates the gallons delivered, divides the gallons by the number of actual stops made within the same date range and arrive at an average gallons/stop value. This is then compared to the ideal value and summarized for all the deliveries to a customer’s tank. Taking this all into account, the potential saved stops is then calculated forming the premise that had the dealer achieved the targeted volume on each delivery, with minimal variation, there would be a number of potential stops that could have been saved to many individual customers, @ $50/delivery.
As an illustration of how important this metric is and how it might affect your company, we analyzed many thousands of customers and their transactions in order to arrive at an average number of deliveries that could be saved as a percentage of total deliveries, by product and tank size. We selected automatics only and those tank sizes common to most. Please take time to digest these numbers and use them to multiply against your total deliveries in order to arrive at your potentially saved deliveries. Please keep in mind that the percentages below were calculated using one year’s activity and as with any average comes higher and lower numbers in the dataset. The purpose of the table below is to illustrate scope of the issue. From the perspective of controlling operating expenses, it is certainly worth taking a look. What are your numbers?
4000 deliveries made to 275 tanks (Auto) in one-year
.10 x 4000 = 400 x $50 = $20,000 for potential deliveries saved for 275’s
- The increase in potential saved deliveries with the increase in tank size for Heating Oil
- The higher percentages of potential saved deliveries in Propane
GREMLIN® Tank Monitors:
- Began beta of RF heating oil monitors
- New Dealer app update available on Google Play or Apple Store
- Began beta of Google Cloud IoT for Angus Monitoring
- ETL Efficiency improved which will decrease the load on the dealer servers
- TMS Portal migrated to Docker Cluster to improve portal stability and performance
BRITE® Business Intelligence Software:
- Average selling price added to the Margin Analysis
- Additional columns added to Delivery Performance
- BRITE v2.5 migrated to Docker Cluster to improve portal stability and performance