Do You Hedge Your Home Heating Oil Exposure?

Being relatively new to the world of home-ownership (we bought our home a little more than 5 years ago) and having already proven that I can make mistakes where more experienced parties would have been smarter, I’ll pose this question to my readership for input.

I was given the option by my oil company to “lock in” the price I pay for home heating oil for the next year.  I’m sure I’m not unique in this regard, but what surprised me was that I thought the offer actually looked pretty decent.  Here’s how it was broken down:

We use an average of 1489 gallons per year.   The price at which the company would sell me oil if I had a delivery today is $2.549, and they’re offering me the ability to guarantee that I won’t pay more than 2.699 for the number of gallons I choose to “protect.”  If I protect, say, 1500 gallons, then I would get the lower of the then-current price at the time of delivery, or 2.699.  Moreso, if I don’t use the whole 1500 gallons, I get a credit for the balance.  It’s not a “pre-purchase.”

So far so good, right?  They’re basically offering me a call option on the price of home heating oil (and note: their letter to me notes that per New Hampshire law, they’re required to hedge all contracts that I hedge: they go and purchase futures and/or options to cover their exposure).  For this hedge, the oil company charges what they call a “nominal fee” of $18/month for the 11 month contract.  What I found interesting was that they told me that this $18/month is the same for everyone – it’s not based on how many gallons you use.

For me, the math they did was : (1489 gallons x $2.699 / 11 ) + $18  = $384 per month.  I’d pay that for 11 months, and if the price of oil was below the $2.699 price I’d capped at, or if I used less oil than 1489 gallons, I’d have a credit balance at the end of the year.

Oil is a sensitive subject for me because, despite the fact that we keep our house relatively cool in the winter (68 degrees), the combination of an old house and frigid New England winters often result in mammoth fuel bills (as you can see by my usage).   At the current cash price ($2.549/gallon), I can expect to pay roughly $3800 for oil next year.  I’m being given the option to lock in a price that’s 6% higher than the current price ($2.699) for a total cost of $18 x 11 = $198.

Rephrased, I’m being offered a 106% call on oil prices for roughly 5% ($198 / $3800).

This seems, well, not so bad?

I put this out there for more experienced homeowners: do you like this deal?  If not, why not?  I’m not really looking to get into a debate that attempts to forecast the future price of oil.

Is there a more efficient way for a guy who is potentially financial-markets-savvy to hedge this exposure?  I see that the CME has a heating oil contract, but a quick check indicated that it was for 42,000 gallons, which doesn’t really make it a very good hedge for me.   A quick look at the crude oil future curve makes it look like I’d be paying a roughly 9% premium to spot for Aug 2016 crude futures, which would also be an imperfect hedge.

Anyway, I thought I’d throw this out there for my reader(s?) to chew on…

-KD

Kid Dynamite is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com. If you click on my Amazon.com links and buy anything, even something other than the product advertised, I earn a small commission, yet you don't pay any extra. Thank you for your support.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

blog comments powered by Disqus
Kiddynamitesworld Blog