Fuel Hedging for Public Entities

Locking in your costs today to help guide budget planning

by Jeff LeMunyon, CFA, Linwood Capital, LLC – Fuel Hedging Advisory

Petroleum and natural gas prices have been extremely high and volatile in the past year due to geopolitical events, global growth and economic uncertainty. Most public entities spent much more than they budgeted for fuel in the past 12 months.

Despite recent price drops, the supply and refining capacity market is tight, and any disruption could cause fuel costs to spike again. Forecasts call for continued uncertainty in fuel pricing. There is an alternative to allowing the volatile energy markets to determine your fuel cost – you can set your costs in advance through fuel hedging.

Fuel hedging is simply “locking in” your cost today for fuel that you will buy and consume later. Fuel hedging contracts can be written up to several years in advance, from 0% to 100% of your projected gasoline, diesel and natural gas consumption. This way, municipalities can accurately budget because the next year’s fuel costs have already been locked in through hedging.

Fuel hedging uses specialized financial instruments to offset movements in fuel costs, and it doesn’t require you to change anything about the way you buy fuel. If prices increase, you’ll pay more at the pump, but the financial instrument will increase in value to cover the increase in your fuel costs. Conversely, if fuel prices drop, you’ll pay less at the pump, but the value of the financial instrument will decrease and offset your lower fuel costs.

Let’s say you’ve locked in your cost at $3.50 a gallon and you use 1,000 gallons per month. You know the monthly cost of your city’s fuel will be $3,500. If the price of fuel in November goes up to $4.00 a gallon, your city would pay $4,000 at the pump, and the hedging instrument would pay you $500 to offset the increase. If the price of fuel in December drops to $3.00 a gallon, you’ll only pay $3,000 for that month’s fill-ups, so you’ll send $500 to your hedging instrument. Your city’s fuel expenses stay at $3,500 a month regardless of the market price.

It is important to establish a statement of Fuel Hedging Policy and Strategy that sets program parameters, governs operations and defines how hedging will be carried out and for what purpose. Retaining an advisor to guide the creation and ongoing operations of the fuel hedging program may also be advantageous. Clear, written policies and guidelines are invaluable in communicating the purpose and goals of the program to elected officials, staff and the public.

It’s all about predictability and the ability to budget accurately. There is little reason for a public entity to expose itself to uncertainty and global risk factors when fuel costs can be managed efficiently through fuel hedging.

Jeff LeMunyon, CFA, is the Principal and Owner with Linwood Capital, LLC.

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