To hedge or not to hedge

By Keith Reid

We, or more specifically I, take a look at hedging in this issue of the magazine. I’ll never admit to being a true expert on such subjects—I often say that if I were I would be enjoying a cocktail on my private yacht somewhere off a tropical island instead of editing a trade magazine.

However, I feel somewhat better when I consider the fact that a great many folk brighter than myself that have specific expertise in such areas never end up on their private yachts, either. The markets will always be a gamble.

When you look at the various forms of risk management with fuel commodities, such as hedging, and the various approaches of going to market with programs either based on those risk management tools or just on what’s happening the at the rack on any given day, you realize pretty quickly that no single approach suits everyone.

The experts I speak with on the hedging side of the industry can make very compelling arguments as to the benefits of absorbing the associated added costs of risk management to provide stability and certainty. Those who offer their customers a variable price approach based on rack price plus margin will note little direct financial risk to “betting wrong” as long as their competitors are playing the same game—but what if they are not?

There is no easy answer. The programs offered to customers supported by various risk management strategies or with variable pricing have tradeoffs. A customer locked in at a specific fixed price one year may be overjoyed when prices move up, yet have steam coming out of his or her ears the following year when prices drop. A price cap program can seemingly solve a great many problems, but then you have to figure out an effective way to pass along cost to the customer. As noted variable pricing can work great if that is common in your market and you have good suppliers, but what about competitors offering those customers more stability?

There are also dealers and marketers who will use hedging as a form of speculation that may or may not pay off. A bit dangerous, in my opinion, if that gamble fails. And there are folks on the hedging side who point out, with some justification, that by not hedging you are speculating on the stability of your competitive environment.

Hedging is typically a solution to volatility and not price, and, as the experts point out, that comes into play when fuel is at $2 per gallon as well as when fuel is at $4 per gallon. My only caveat to that would be that from an emotional standpoint, customers will likely be more forgiving of having made a “wrong choice” with a price protection plan or getting the invoice for an unfavorable rack price that particular delivery with today’s lower prices. But that shouldn’t lead to any backsliding on the efficiency front, as the competitive pressures the industry faces internally are certainly not going away.

Every customer does count, and putting the effort into developing a solid commodity purchasing strategy is certainly worth the time and effort. There are a lot of experts who can provide you with an understanding of the various options you may or may not be familiar with, and, of course, you know your customers and your competitive landscape. Doing things the way you’ve always done that might be entirely appropriate, but there might be a better way or several better ways. Only you can make that call.