Hedge Your Bets

Hedge Your Bets
A short term hedge doesn’t offer much protection since fuel prices are so fickle.

Fuel hedging provides insurance, but also risk.

As rising gas prices send blood pressure rates soaring, some fleet managers may be tempted to try extreme measures – like fuel hedging.

However, Andy Hall, system manager, fuel and GMS products for ARI, notes that none of his clients are soaring. “We’ve had a few clients in the U.S. recently ask us about it,” he says. “It’s a financial instrument, and you can look at it as an insurance policy for fuel prices going up. But it has to go through the organization and up to someone like a CFO, and sometimes they’re just not comfortable with it. They remember the days of the airlines hedging and losing a lot of money.”

Hall says ARI has a relationship with Stabilitas Energy Inc., an energy consultancy firm. “If we have fuel data for a client, we can provide that, and Stabilitas can do an analysis, take a look at different options and model out how different hedging instruments would help, and look at break even points and costs,” says Hall. “It helps the client see if it’s something they’d be interested in or not.”

Insurance premium

If a client was locked in through a financial instrument, and prices continued to rise, there’d be a premium price. “That’s similar to an insurance premium, so there would be a break even point,” explains Hall. “If prices just stayed right there, then they would be out the premium and they wouldn’t benefit from it.”

For example, if gas prices were three dollars a gallon, and the break even point with the premium would be $3.20… “If prices don’t go above $3.20, then that client doesn’t benefit from the hedge,” says Hall. “They have the security of knowing that if prices do go up, they would benefit. But if prices go down, and they’re paying a premium on protection for prices going up, they’re not benefiting from the lower fuel cost. So there’s risk either way.”

In the U.S., fleets can implement a hedge from one to three months, or for several years. However, a short term hedge doesn’t offer much protection since fuel prices are so fickle.

Much can be learned from the airline industry, which started using fuel hedging—often with disastrous results. Air Canada started a fuel hedging strategy in the summer of 2008, but five months later, when fuel prices dropped by about 68 percent, they were unable to take advantage of the plummet in price.

Understand goals

It’s important to understand what your goals are. “If it’s important to have a stable budget, and organizationally it’s important to make sure you’re budgeting a certain number for fuel, that’s what you want to hit,” says Hall. “Or you’re convinced that fuel is going to go through the roof and you want some protection from that.

“The pros are that you get some upside protection. The cons would be if fuel prices drop unexpectedly while you’re paying a premium for your hedging. You can hedge a portion of your spend on fuel, just like partial insurance.”

However, in Canada, there are no underwriters that offer derivatives to hedge, according to Hall. “In the U.S., there are a number of different instruments that you can use,” he says. “I don’t know what actual opportunity there would be for fleets in Canada.”

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