ANALYSIS Fuel Hedging — The Reality Even though fuel hedging has been used successfully for decades in the energy and trans- By John Ricks
portation industries (airlines, cruise lines, etc.), some in the public sector appear to be fearful of the program and, hence, are reluctant to stabilize their fuel budgets with using these types of programs. I believe that this fear and reluctance comes from a lack of under- standing of how a fuel hedging program works, and in some cases from misconceptions and misrepresentations about the process. My goal in this synopsis is to clear up the misconceptions, confront the misrepresenta- tions and explain the process of hedging fuel as concisely as possible.
MISCONCEPTIONS & MISREPRESENTATIONS 1. It’s a Gamble — Actually the opposite is true. Not fixing your fuel price is gambling
that the market is going down or at least going to stay the same. If the market goes up sig- nificantly, like it did earlier this year, you wind up with a budget deficit. Tose entities who hedged their fuel costs took the uncertainty out of the equation and therefore had a “sure thing” (fixed fuel price), not a gamble. 2. You can lose your shirt — Tis misconception is closely associated with the idea that
fuel hedging is a gamble (win big or lose big). Nothing could be further from the truth. Te goal of fuel hedging is to stabilize your budget so that you know exactly what you will pay for fuel. Once you select a price that is in keeping with your budget, you’re finished! Tat’s the price you’ll pay…you’ve removed the uncertainty of market fluctuations. Tere are no wins or losses to be had, just the certainty of knowing what you will pay for fuel regardless of what happens in the market. 3. You’re penalized if you don’t use the exact amount of fuel that you hedge — Tis
is incorrect! Tere are no such penalties. With a financial hedge, the amount of fuel you use does not have to equal the amount of fuel you hedge. Even with a physical hedge there are typically no penalties as long as you take delivery of the fuel during the specified time period. 4. Investment Banks make a “killing” from the fuel hedge customer — Again, this is
an idea that comes from a lack of understanding about the process. Typically, investment banks only hedge fuel for the very largest of fuel consumers (more than 100 million gallons per year). School districts, cities and other smaller consumers hedge their fuel with smaller fuel hedge companies. Tese companies add a small premium to the fixed price of fuel, which amounts to a few cents per gallon. Because these companies are not investors or speculators, they make the same amount of money regardless of what happens in the mar- ket. Actually, many large users of fuel also use fuel hedge companies rather than investors.
According to a School Transportation News survey conducted this past spring,
transportation directors and supervisors from across the country reported that, on aver- age the operations spent $372,305 on fuel during the 2010-2011 school year. Tis year, those same respondents indicated they had a budget of $427,997 for fuel, an increase of 15 percent. Te school bus operators were also asked which option they consider more risky, paying a fixed price for fuel over a given period of time or paying market prices that can fluctuate. Tirty-six percent said the latter compared to 30 percent who said there is more risk in locking into a set price. Te remaining 34 percent said they were unsure. In- terestingly, 49 percent of the same people said they did not know if fuel hedging should be a part of any prudent fuel management program. Meanwhile, 31 percent answered this is a true statement while 20 percent answered false. One respondant said the most effective risk management is to use both means of fuel hedging and market pricing.
38 School Transportation News Magazine November 2011
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