creating value through fuel price risk management
DESCRIPTION
An overview of fuel price risk management: what it is, how it works, how it is applied, and the results of its application. Jeff LeMunyon will address fuel price risk management policy, strategy, philosophy, tools and how value is added by applying a systematic approach to fuel price risk management in a public transit setting.TRANSCRIPT
Creating ValueThrough
Fuel Price Risk Management2009 NYPTA Fall Conference
Linwood Capital, LLC4316 Eton Place
Edina, Minnesota 55424Telephone: 952.285.1134Facsimile: 952.285.1135
E-mail: [email protected]: www.linwoodcapital.com
Energy Price Risk Management
Can Energy Costs Be Controlled? Yes, Through Forward Pricing: Establishing the Price Today
for Energy That Will Be Consumed later.
What is the Result of Forward Pricing? Reducing or Eliminating the Range of Probable Energy
Costs Over a Future Time Period. Lower Budget Risk More Certain Future Fuel Costs Less Fuel Cost Volatility Seeks Low Overall Cost
Energy Price Risk Management
How Should Hedging be Approached? How Much Risk is There? What Percentage of Projected Consumption Should be
Hedged? How Far Forward Should Costs be “Locked In” What Instruments Should Be Used? What About Strategy and Techniques? What About a Policy?
Energy Price Risk Management
What do the Energy Markets Tell Us? Today’s Price – Current Cost Expected Prices – Cost Expectations Expected Range of Expected Prices – Level of Uncertainty
Associated with Expected Prices How Much Risk the Market Has
Energy Price Risk Management
Why is this Information Useful? Planning Budgeting Forecasting Quantifying Risk Exposure – Is There More Cost Uncertainty
than is Tolerable? If “Yes”, then forward pricing is needed to control risk
Energy Price Risk Management
No Hedging
Wide Range ofExpected Cost
Maximum RiskExposure
High Budget Risk
Forecasted prices assume heating oil futures prices and heating oil implied option volatility on 8/31/09Forecasted prices assume that costs will be equivalent to HO futures + 14.12 cents per gallonUpper and lower limits represent plus and minus one standard deviation of expected price movement as implied by heating oil options pricing
Unhedged AnalysisAugust 31, 2009
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Benchmark Pricing Curve Benchmark Upper LimitBenchmark Lower Limit
Energy Price Risk Management
Hedging
Narrower Range ofExpected Cost
Managed RiskExposure
More CertainFuture Costs
Forecasted prices assume heating oil futures prices and heating oil implied option volatility on 8/31/09Forecasted prices assume that costs will be equivalent to HO futures + 14.12 cents per gallonUpper and lower limits represent plus and minus one standard deviation of expected price movement as implied by heating oil options pricing
90% Hedged AnalysisAugust 31, 2009
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Month
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Benchmark Pricing Curve Benchmark Upper LimitBenchmark Lower Limit
Energy Price Risk Management
Results & Benefits of Forward Pricing The Consumption of Energy is no Longer Simultaneous with
the Pricing of the Energy. Risk Reduction
Lower Budget Risk Higher Certainty of Future Energy Costs
Organizational Benefits Enhanced Ability to Forecast, Plan & Budget Organizational Stress Caused by Going Over Budget is
Reduced or Eliminated No longer at the Mercy of Volatile Energy Market Prices Opportunity to seek lowest overall cost while managing risk
Manage risk in light of market environment Manage Risk as the market present it (higher prices) Capture Opportunity as the Market Presents it (lower prices) Tactically time market transactions seeking lowest overall cost
Eliminate only the risk that cannot be tolerated More forward pricing near-term Less forward pricing further forward
Use time as an advantage Forward pricing window long enough to create desired cost
certainty Forward pricing window long enough to allow adjustments
during market fluctuations
Energy Price Risk ManagementStrategy
Energy Price Risk ManagementPolicy
Which Instruments Should Be Used? Fixed price supply contracts Swaps, Caps, Collars Exchange-Traded instruments Hybrid Pools
How Far Forward Should Hedging Go? The Need for Cost Certainty The Desire to Address Market Opportunity
What Percentage of Consumption Needs to Be Hedged? Maximum Based on Potential Variability in Consumption Level Based on Need for Cost Certainty
Energy Price Risk ManagementManagement Techniques
Static Few Transactions with Larger Volumes Per Transaction Market Conditions Typically Not Considered Typically Swaps or Fixed Price Supply Contracts
Semi Dynamic Many Transactions with Smaller Volumes Per Transaction Typically “Rolling” Position Forward in a Static Time Frame Transactions Somewhat Based on Market Conditions and Client Risk Typically Swaps or Exchange-Traded Futures or Both
Fully Dynamic Many Transactions with Smaller Volumes Per Transaction Transactions Based on Market Conditions and Client Risk Exchange-Traded Futures or Swaps or Both Positions Can be Traded According to Changing Market Conditions Allows Consistency of Client Risk in Changing Market Conditions
Example Forward Pricing Performance
Spot Price vs. Hedged CostDiesel Fuel1997-2008
$0.00
$0.50
$1.00
$1.50
$2.00
$2.50
$3.00
$3.50
$4.00
$4.50
Pri
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Spot Price Net Hedged Cost
Assuming 24 month forward pricing window and 100% hedged
Forward Pricing Example – Price Increase
Forward Pricing ExampleBudget = $2.60 per gallon
Actual Fuel Cost From Supplier $3.00 per gallon x 300,000 gals for one month. $900,000.00
Forward Pricing:6 Forward Pricing Contracts (84% hedged)
(6x42,000 gallons = 252,000 gallons)
Contract buy price = $2.50 per gallonAverage Contract sell price = $3.00 per gallonRealized Gain = $0.50 per gallon
Realized Gain (negative fuel cost) =$0.50 per gallon x 252,000 gals. ($126,000.00)
Net Fuel Cost = $2.58 per gallon $774,000.00
Forward Pricing ExampleBudget = $2.60 per gallon
Actual Fuel Cost From Supplier $2.00 per gallon x 300,000 gals for one month. $600,000.00
Forward Pricing:6 Forward Pricing Contracts (84% hedged)
(6x42,000 gallons = 252,000 gallons)
Contract buy price = $2.50 per gallonAverage Contract sell price = $2.00 per gallonRealized Loss = $0.50 per gallon
Realized Loss (positive fuel cost) =$0.50 per gallon x 252,000 gals. $126,000.00
Net Fuel Cost = $2.42 per gallon $726,000.00
Forward Pricing Example – Price Decrease
Summary Factors beyond our control cause energy prices to be volatile
and uncertain
Public entities do not benefit from energy market exposure
Forward Pricing is avoiding energy market exposure
Forward Pricing is deciding today what tomorrow’s cost will be
This is accomplished through using financial instruments or fixed price supply contracts designed for this purpose
Having a policy and strategy is important in meeting goals and expectations