When I mention the topic of hedging to terminal operators, those without product ownership think they are ruled out. Not so. While attention is often given to managing the value of commodities in storage through NYMEX based futures and options, little mention is made of applying these same techniques to operating margins.

Terminals generate operating margins by the throughput and storage of product. However, market conditions may act as a disincentive for your customers to store product. During these times, inventories decline along with your margins. Knowing this relationship exists, you can develop hedging strategies to offset the loss.

The NYMEX trades in future months establishing a forward price curve. The shape of this curve determines whether customers have an incentive to carry inventory. If prices are poised to rise at a rate higher than the cost of carry, customers have an incentive to build inventory. If the market shows declining product values, that becomes our signal to implement a hedge position in anticipation of declining inventory. The hedge is a NYMEX trade designed to make money in a market of depreciating forward prices. The profit made on this trade is used to offset reduced operating margins.

Think of hedging the way you would insurance. You pay a non-refundable premium to protect against major losses. The result is a more predictable bottom line, and in many cases an improved bottom line with the major losses removed.

This article was written by J. Scott Susich, Senior Analyst with Energy Management Institute.

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