The Risky Business of Hedging

I came across an interesting article in The Wall Street Journal this week suggesting that the NYMEX crude contract may be ceasing to work as a benchmark for international hedging of crude oil price exposure.

We’ve recently seen that high storage levels in Cushing, Okla., have depressed NYMEX crude prices relative to similar sweet crudes in Europe – ordinarily NYMEX crude should be trading at a premium but instead it is about $3 below Brent crude, a very similar grade of crude that comes out of the North Sea.

The result is that people looking to the NYMEX contract to hedge their crude oil exposure may not be protected – if a refinery, for example, had purchased NYMEX to hedge its crude oil feedstock exposure and yet purchased its physical from the UK, its hedges would not work and it would pay at least $3 more per barrel for the imported crude – customers like this would be understandably angry.

Enough of the technical stuff. How is this relevant to MXenergy’s customers?

First, it illustrates how the NYMEX contracts are imperfect hedges, at best. It also means that businesses that use the NYMEX to hedge, such as in trigger deals – may not be happy if the NYMEX price were to fail to track physical market transactions – any customer that was triggering off the NYMEX would find themselves paying much more than they would have if they had locked in their basis.

Alternatively, imagine if there were a mid-continent pipeline explosion that trapped gas in the gulf so that prices in the gulf stayed low while the physical market near the customer took off – without being hedged with a fixed price, the customer might suddenly find itself paying high prices even though the NYMEX looked low – another reason for fixed prices!

Finally, it shows how extraneous market forces – a refinery outage in Texas, for example – can have an impact that reaches around the world to an airline in Europe hedging its jet fuel, to a producer in the Mideast hedging its production, to a ship in the far east hedging its bunker fuel.

Likewise, a lot of things can affect the prices of gas in the Gulf of Mexico – such as the current unrest in Nigeria – that may not look relevant to our customers at the time.

That’s why we’re constantly keeping a close eye on global and economic developments for you. What do you think? We’d love to hear from you.