Commodity / Financial Futures RBC Dominion Securities Inc.
Hedging diesel
The Simpson/Caputo Group
One common method for hedging diesel is using the liquid No.2 Heating Oil futures contract traded on the CME Group Exchange (which will be replaced by a new “New York Harbor Ultra-Low Sulfur Diesel” contract beyond the August 2012 contract). 95 King St S Heating oil futures is frequently used for the hedge because the two fuels 3rd Floor are produced together and chemically similar; they both belong to the Waterloo ON N2J 5A2 distillate fuel oil group, including jet fuel, kerosene, etc. Diesel fuel is often priced at a stable premium to that of heating oil. But it is important to note 1-866-989-0997 that while hedging diesel fuel through heating oil futures can be effective, 519-747-7221 the different quality specifications of the two products after all introduce an [email protected] element of risk – basis risk.
Thank you for your referrals EXAMPLE
In March, an independent trucking company which uses diesel fuel for its We are growing our business so if you have any friends or family fleet, is looking to forward contract supplies for September, seeing that members who may benefit from current prices appear to be at bargain levels. But because of the volatile our services, please let us know. fuel oil market of late, fuel oil distributors are reluctant to forward commit We would be happy to meet with with a firm price more than 30 days in advance. And with private forecasts them. calling for tighter supplies, higher fuel oil prices by September 1, it decides to fix its fuel cost for the fall, to lock in profitable cost levels and better manages its cash flow. On March 15, the trucking company, calculating that it needs 126,000 gallons for the fall months, decides to buy three October Heating Oil futures at $2.9830/gallon. The size of one contract of heating oil
Professional Wealth Management Since 1901 futures is 42,000 gallons (one US gallon equals 3.785 litres).
Cash Diesel October Heating Oil futures March 15 $3.0310/gallon $2.9830/gallon
By September 1, distillate fuel prices have risen as anticipated, the trucking company decides to buy the diesel in the market and simultaneously sell the October Heating Oil futures to close out the hedge.
Cash Diesel October Heating Oil futures Sept. 1 $3.1330/gallon $3.0670/gallon
The gain in October Heating Oil futures: ($3.0670 - $2.9830) x 126,000 = $10,584
The higher cost for diesel: (3.1330 – 3.0310) x 126,000 = $12,852
Although the gain in heating oil futures is less than that in cash diesel, by hedging with heating oil futures, the trucking company is able to offset much of the higher diesel cost. On the other hand, if distillate fuel oil prices have fallen instead, and provided that the heating oil/diesel basis stays relatively stable, as seen in the example above, the loss in October Heating Oil futures would be offset by the lower cost in diesel, and again the trucking company would have locked in a diesel price at the March 15 price minus the cost of the hedge. For more information about diesel hedging, or commodity/financial futures, please contact us.
Futures or options trading involves substantial risk, may result in serious financial loss, and is not suitable for all investors or portfolios. The information contained in this article is not intended as a recommendation directed to a particular investor or class of investors and is not intended as a recommendation in view of the particular circumstances of a specific investor, class of investors or a specific portfolio. You should not take any action with respect to any securities or investment strategy mentioned in this article without first consulting your own investment advisor in order to ascertain whether the securities or investment strategy mentioned are suitable for your circumstances. The information contained herein has been obtained from sources believed to be reliable at the time obtained but neither RBC Dominion Securities Inc. nor its employees, agents, or information suppliers can guarantee its accuracy or completeness. This brochure is not and under no circumstances is to be construed as an offer to sell or the solicitation of an offer to buy any securities. It is furnished on the basis and understanding that neither RBC Dominion Securities Inc. nor its employees, agents, or information suppliers is to be under any responsibility or liability whatsoever in respect thereof. RBC Dominion Securities Inc.* and Royal Bank of Canada are separate corporate entities which are affiliated. *Member-Canadian Investor Protection Fund. ® Registered trademark of Royal Bank of Canada. Used under licence. RBC Dominion Securities is a registered trademark of Royal Bank of Canada. Used under licence. © Copyright 2011. All rights reserved.