Creating Value Through Fuel Price Risk Management 2009 NYPTA Fall Conference Linwood Capital, LLC 4316 Eton Place Edina, M...
Energy Price Risk Management <ul><li>Can Energy Costs Be Controlled? </li></ul><ul><ul><li>Yes, Through Forward Pricing:  ...
Energy Price Risk Management <ul><li>How Should Hedging be Approached? </li></ul><ul><ul><li>How Much Risk is There? </li>...
Energy Price Risk Management <ul><li>What do the Energy Markets Tell Us? </li></ul><ul><ul><li>Today’s Price – Current Cos...
Energy Price Risk Management <ul><li>Why is this Information Useful? </li></ul><ul><ul><li>Planning </li></ul></ul><ul><ul...
Energy Price Risk Management No Hedging Wide Range of Expected Cost Maximum Risk Exposure High Budget Risk Forecasted pric...
Energy Price Risk Management Hedging Narrower Range of Expected Cost Managed Risk Exposure More Certain Future Costs Forec...
Energy Price Risk Management <ul><li>Results & Benefits of Forward Pricing </li></ul><ul><ul><li>The   Consumption   of En...
<ul><ul><li>Manage risk in light of market environment </li></ul></ul><ul><ul><ul><li>Manage Risk as the market present it...
Energy Price Risk Management Policy <ul><li>Which Instruments Should Be Used? </li></ul><ul><ul><li>Fixed price supply con...
Energy Price Risk Management Management Techniques <ul><li>Static </li></ul><ul><ul><li>Few Transactions with Larger Volum...
Example Forward Pricing Performance Assuming 24 month forward pricing window and 100% hedged
Forward Pricing Example – Price Increase <ul><li>Forward Pricing Example </li></ul><ul><li>Budget  = $2.60 per gallon </li...
Forward Pricing Example – Price Decrease <ul><li>Forward Pricing Example </li></ul><ul><li>Budget  = $2.60 per gallon </li...
Summary <ul><li>Factors beyond our control cause energy prices to be volatile and uncertain </li></ul><ul><li>Public entit...
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Creating Value Through Fuel Price Risk Management

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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.

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Creating Value Through Fuel Price Risk Management

  1. 1. Creating Value Through Fuel Price Risk Management 2009 NYPTA Fall Conference Linwood Capital, LLC 4316 Eton Place Edina, Minnesota 55424 Telephone: 952.285.1134 Facsimile: 952.285.1135 E-mail: [email_address] Website: www.linwoodcapital.com
  2. 2. Energy Price Risk Management <ul><li>Can Energy Costs Be Controlled? </li></ul><ul><ul><li>Yes, Through Forward Pricing: Establishing the Price Today for Energy That Will Be Consumed later. </li></ul></ul><ul><li>What is the Result of Forward Pricing? </li></ul><ul><ul><li>Reducing or Eliminating the Range of Probable Energy Costs Over a Future Time Period. </li></ul></ul><ul><ul><li>Lower Budget Risk </li></ul></ul><ul><ul><li>More Certain Future Fuel Costs </li></ul></ul><ul><ul><li>Less Fuel Cost Volatility </li></ul></ul><ul><ul><li>Seeks Low Overall Cost </li></ul></ul>
  3. 3. Energy Price Risk Management <ul><li>How Should Hedging be Approached? </li></ul><ul><ul><li>How Much Risk is There? </li></ul></ul><ul><ul><li>What Percentage of Projected Consumption Should be Hedged? </li></ul></ul><ul><ul><li>How Far Forward Should Costs be “Locked In” </li></ul></ul><ul><ul><li>What Instruments Should Be Used? </li></ul></ul><ul><ul><li>What About Strategy and Techniques? </li></ul></ul><ul><ul><li>What About a Policy? </li></ul></ul>
  4. 4. Energy Price Risk Management <ul><li>What do the Energy Markets Tell Us? </li></ul><ul><ul><li>Today’s Price – Current Cost </li></ul></ul><ul><ul><li>Expected Prices – Cost Expectations </li></ul></ul><ul><ul><li>Expected Range of Expected Prices – Level of Uncertainty Associated with Expected Prices </li></ul></ul><ul><ul><li>How Much Risk the Market Has </li></ul></ul>
  5. 5. Energy Price Risk Management <ul><li>Why is this Information Useful? </li></ul><ul><ul><li>Planning </li></ul></ul><ul><ul><li>Budgeting </li></ul></ul><ul><ul><li>Forecasting </li></ul></ul><ul><ul><li>Quantifying Risk Exposure – Is There More Cost Uncertainty than is Tolerable? </li></ul></ul><ul><ul><li>If “Yes”, then forward pricing is needed to control risk </li></ul></ul>
  6. 6. Energy Price Risk Management No Hedging Wide Range of Expected Cost Maximum Risk Exposure High Budget Risk Forecasted prices assume heating oil futures prices and heating oil implied option volatility on 8/31/09 Forecasted prices assume that costs will be equivalent to HO futures + 14.12 cents per gallon Upper and lower limits represent plus and minus one standard deviation of expected price movement as implied by heating oil options pricing
  7. 7. Energy Price Risk Management Hedging Narrower Range of Expected Cost Managed Risk Exposure More Certain Future Costs Forecasted prices assume heating oil futures prices and heating oil implied option volatility on 8/31/09 Forecasted prices assume that costs will be equivalent to HO futures + 14.12 cents per gallon Upper and lower limits represent plus and minus one standard deviation of expected price movement as implied by heating oil options pricing
  8. 8. Energy Price Risk Management <ul><li>Results & Benefits of Forward Pricing </li></ul><ul><ul><li>The Consumption of Energy is no Longer Simultaneous with the Pricing of the Energy. </li></ul></ul><ul><ul><li>Risk Reduction </li></ul></ul><ul><ul><ul><li>Lower Budget Risk </li></ul></ul></ul><ul><ul><ul><li>Higher Certainty of Future Energy Costs </li></ul></ul></ul><ul><ul><li>Organizational Benefits </li></ul></ul><ul><ul><ul><li>Enhanced Ability to Forecast, Plan & Budget </li></ul></ul></ul><ul><ul><ul><li>Organizational Stress Caused by Going Over Budget is Reduced or Eliminated </li></ul></ul></ul><ul><ul><li>No longer at the Mercy of Volatile Energy Market Prices </li></ul></ul><ul><ul><li>Opportunity to seek lowest overall cost while managing risk </li></ul></ul>
  9. 9. <ul><ul><li>Manage risk in light of market environment </li></ul></ul><ul><ul><ul><li>Manage Risk as the market present it (higher prices) </li></ul></ul></ul><ul><ul><ul><li>Capture Opportunity as the Market Presents it (lower prices) </li></ul></ul></ul><ul><ul><ul><li>Tactically time market transactions seeking lowest overall cost </li></ul></ul></ul><ul><ul><li>Eliminate only the risk that cannot be tolerated </li></ul></ul><ul><ul><ul><li>More forward pricing near-term </li></ul></ul></ul><ul><ul><ul><li>Less forward pricing further forward </li></ul></ul></ul><ul><ul><li>Use time as an advantage </li></ul></ul><ul><ul><ul><li>Forward pricing window long enough to create desired cost certainty </li></ul></ul></ul><ul><ul><ul><li>Forward pricing window long enough to allow adjustments during market fluctuations </li></ul></ul></ul>Energy Price Risk Management Strategy
  10. 10. Energy Price Risk Management Policy <ul><li>Which Instruments Should Be Used? </li></ul><ul><ul><li>Fixed price supply contracts </li></ul></ul><ul><ul><li>Swaps, Caps, Collars </li></ul></ul><ul><ul><li>Exchange-Traded instruments </li></ul></ul><ul><ul><li>Hybrid </li></ul></ul><ul><ul><li>Pools </li></ul></ul><ul><li>How Far Forward Should Hedging Go? </li></ul><ul><ul><li>The Need for Cost Certainty </li></ul></ul><ul><ul><li>The Desire to Address Market Opportunity </li></ul></ul><ul><li>What Percentage of Consumption Needs to Be Hedged? </li></ul><ul><ul><li>Maximum Based on Potential Variability in Consumption </li></ul></ul><ul><ul><li>Level Based on Need for Cost Certainty </li></ul></ul>
  11. 11. Energy Price Risk Management Management Techniques <ul><li>Static </li></ul><ul><ul><li>Few Transactions with Larger Volumes Per Transaction </li></ul></ul><ul><ul><li>Market Conditions Typically Not Considered </li></ul></ul><ul><ul><li>Typically Swaps or Fixed Price Supply Contracts </li></ul></ul><ul><li>Semi Dynamic </li></ul><ul><ul><li>Many Transactions with Smaller Volumes Per Transaction </li></ul></ul><ul><ul><li>Typically “Rolling” Position Forward in a Static Time Frame </li></ul></ul><ul><ul><li>Transactions Somewhat Based on Market Conditions and Client Risk </li></ul></ul><ul><ul><li>Typically Swaps or Exchange-Traded Futures or Both </li></ul></ul><ul><li>Fully Dynamic </li></ul><ul><ul><li>Many Transactions with Smaller Volumes Per Transaction </li></ul></ul><ul><ul><li>Transactions Based on Market Conditions and Client Risk </li></ul></ul><ul><ul><li>Exchange-Traded Futures or Swaps or Both </li></ul></ul><ul><ul><li>Positions Can be Traded According to Changing Market Conditions </li></ul></ul><ul><ul><li>Allows Consistency of Client Risk in Changing Market Conditions </li></ul></ul>
  12. 12. Example Forward Pricing Performance Assuming 24 month forward pricing window and 100% hedged
  13. 13. Forward Pricing Example – Price Increase <ul><li>Forward Pricing Example </li></ul><ul><li>Budget = $2.60 per gallon </li></ul><ul><li>Actual Fuel Cost From Supplier </li></ul><ul><li>$3.00 per gallon x 300,000 gals for one month. $900,000.00 </li></ul><ul><li>Forward Pricing: </li></ul><ul><ul><li>6 Forward Pricing Contracts (84% hedged) </li></ul></ul><ul><ul><li>(6x42,000 gallons = 252,000 gallons) </li></ul></ul><ul><ul><li>Contract buy price = $2.50 per gallon </li></ul></ul><ul><ul><li>Average Contract sell price = $3.00 per gallon </li></ul></ul><ul><ul><li>Realized Gain = $0.50 per gallon </li></ul></ul><ul><li>Realized Gain (negative fuel cost) </li></ul><ul><li> =$0.50 per gallon x 252,000 gals. ($126,000.00) </li></ul><ul><li>Net Fuel Cost = $2.58 per gallon $774,000.00 </li></ul>
  14. 14. Forward Pricing Example – Price Decrease <ul><li>Forward Pricing Example </li></ul><ul><li>Budget = $2.60 per gallon </li></ul><ul><li>Actual Fuel Cost From Supplier </li></ul><ul><li>$2.00 per gallon x 300,000 gals for one month. $600,000.00 </li></ul><ul><li>Forward Pricing: </li></ul><ul><ul><li>6 Forward Pricing Contracts (84% hedged) </li></ul></ul><ul><ul><li>(6x42,000 gallons = 252,000 gallons) </li></ul></ul><ul><ul><li>Contract buy price = $2.50 per gallon </li></ul></ul><ul><ul><li>Average Contract sell price = $2.00 per gallon </li></ul></ul><ul><ul><li>Realized Loss = $0.50 per gallon </li></ul></ul><ul><li>Realized Loss (positive fuel cost) </li></ul><ul><li> =$0.50 per gallon x 252,000 gals. $126,000.00 </li></ul><ul><li>Net Fuel Cost = $2.42 per gallon $726,000.00 </li></ul>
  15. 15. Summary <ul><li>Factors beyond our control cause energy prices to be volatile and uncertain </li></ul><ul><li>Public entities do not benefit from energy market exposure </li></ul><ul><li>Forward Pricing is avoiding energy market exposure </li></ul><ul><li>Forward Pricing is deciding today what tomorrow’s cost will be </li></ul><ul><li>This is accomplished through using financial instruments or fixed price supply contracts designed for this purpose </li></ul><ul><li>Having a policy and strategy is important in meeting goals and expectations </li></ul>
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