Hedging your winter oil bills

Posted by: Aaron Pressman on April 10, 2006

One of the new oil ETFs (Symbol: USO) started trading today, allowing investors to buy shares of a barrel of oil without the complications and risks of using the futures market. Already you can see some hysterics who say don’t touch the fund with a ten-foot pole.

In some ways, they’re right. I’m not sure how much success anyone would have just guessing where the price of oil is headed over the short-term. And based on recent conversations with fund managers like Dan Rice of the Blackrock Global Natural Resources Fund (SSGRX), the smarter play may be to buy shares of energy producers that the market is valuing based on much lower than current prices of oil and coal. Rice’s fund owned coal companies like Peabody Energy (BTU) and Arch Coal (ACI) among its top holdings on 12-31-05. That said, there are probably times when the reverse is true and it might make sense to own oil directly instead of the producers. Now it’s an easy swap.

I can also think of at least one way that the existence of the ETF creates a new opportunity for individual investors to hedge, especially in a world of $8 online trading commissions. For example, we paid a couple of thousand dollars this winter for heating oil and it wasn’t even a particularly cold winter. Living in an old, drafty house, we are greatly at risk of higher oil prices. If it had been as cold as 2004, our oil bills would have been positively scary.

What if in the warmer season, I invested that couple of thousand dollars in the oil ETF? Then as I get my monthly oil bills over next winter, I sell down the holdings to pay for heating. If the price of oil falls, I lose money on the ETF but it’s offset by savings in my winter bills. Price of oil rises, I’m covered, even if the price rises a lot. One data point to check first would be the correlation between home heating oil and the raw crude price used for the ETF. I’d guess that they’re pretty close. I’m also not hedged against the weather. Falling oil prices and a warmer winter (a natural combination) would leave me with bigger losses on my hedge than savings on my heating bills. That suggests setting up only a partial hedge.

My costs would be the trading commissions, a percent or so, and the opportunity cost of not having the money in a bank account or money market fund, just a few more percent lost. Since the price of oil could double, that seems like a small price to pay. Some heating oil companies allow customers to lock-in a price for the season ahead of time, which is another possible alternative. That wouldn’t have the weather-related consumption risk though depending on the date and price of the lock-in offer, might be a lot less of a hedge.

Reader Comments

al haslam

April 10, 2006 4:52 PM

i might be wrong, but i think if you are paying that much for heating you might be better spendcouple of thousand to upgrade insulation and weaterstripping!

Miserly Bastard

April 10, 2006 6:29 PM

I posted a comment on your article on my own blog.

Aaron Pressman

April 11, 2006 11:41 AM

Good points, all. We already spent the max to improve energy efficiency. As to correlation, which I also discussed above, we buy heating oil not natural gas or electricity. I could be wrong but correlation should be very close. Finally, the tax issue is a good one. This strategy may have to await call options on the USO.

Gerard Rotonda

April 13, 2006 8:00 PM

Yes, Price of oil rises - you are covered.

Walt Coleman

June 15, 2009 6:56 PM

Another consideration....if you don't mind a little speculation.
Between now...early summer and winter there most assuredly will be some world tension (like Israel or Iran) that will spike the price. Wait for a good spike and jump out.....if things settle back down jump back in. But the key is to get in when tensions are down and jump out after the the "tension spike"

Post a comment

 

About

Bloomberg Businessweek’s Ben Steverman focuses on the latest moves in financial markets and emerging trends in stocks, bonds, and funds, always with an eye toward giving readers a better understanding of the sometimes confusing and often chaotic world of money. Standard & Poor’s senior index analyst Howard Silverblatt will also provide his take on companies’ finances and the markets. Voted one of the “Top 100 Finance Blogs” in 2007.

BW Mall - Sponsored Links

Buy a link now!