November 04, 2008
Hedging, Speculation, Investors and Customers
Posted by Christine Hurt

I am working on a project exploring public perception of hedging and speculation.  Because of this interest, I noticed two articles in the NYT a week or so ago (yes, I'm a little behind on blogging).  The first article was titled "Some Regret Locking in Price for Oil," and reported that customers who rely on home-delivered heatin oil to heat their homes in the winter were given the chance to lock in the price of that heating oil this summer.  Many did, but of course the market price for heating oil is now down to around $3 a gallon.  This summer, customers signed contracts for fixed prices above $4 a gallon.  If the price of heating oil had continued to rise, then the customers would feel very smart; instead the price has dropped and now they are complaining to their heating oil companies. 

The second article, "Fuel Hedges Cause a Loss at Northwest," appeared in a different section of the paper.  Although fuel has gone down, any profits were wiped out because of its hedges on fuel oil.  The article doesn't say what types of hedges Northwest bought or what the terms were, but it should be a wash if Northwest was truly hedging.  Other than the costs of the hedging contracts, true heding shouldn't cause a true loss, although it could wipe out a potential profit due to falling fuel costs.

So in these two stories, the customers and Northwest did the same thing -- tried to be prudent in the face of rising fuel costs.  For Northwest, who is a user of fuel to create a product, hedging should reduce risk -- both downside risk and upside potential.  However, for the customers, who are end-users of fuel, their fixed-price contracts reduced their exposure to the risk of rising oil prices but left them vulnerable when the price declined.  But that's the nature of future contracts, right?  They are investments, and sometimes investments go down and sometimes they go up.

However, in the case of the heating oil customers, some vendors are negotiating with their customers and not making them bear the full loss.  A condominium is mentioned as being able to negotiate a different price for 2009, and a later blog entry on the NYT City Room reports that a Long Island woman quoted in the article was contacted by her oil company, which reduced her price per gallon by $.50.  The company said it made sense from a customer relations standpoint.

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