Manufacturer realizes big savings with diesel hedge strategy
Learn how Summit crafted a risk management strategy for a large industrial facility that achieved cost certainty for the company.
Weighing risk management strategy with market intelligence leads to diesel savings: At an industrial facility outside the United States, where diesel fuel is the largest expense, a large manufacturing client cannot pass through energy costs to the customer. In order to set budget expectations and control cash flow at the site, the client asked Summit Energy to develop a purchasing plan over six quarters that would hedge diesel costs and have minimal impact on the company’s bottom line.
The manufacturing firm was spending approximately $1.2 million on diesel fuel, at a single physical price point: Platts U.S. Gulf Coast No. 2 at $2.63/gallon. Summit’s goal was to develop a risk management strategy that would manage volatility and upside price risk. The client needs to protect and predict its cash flows. It is publicly traded, thus volatility in earnings is undesirable. Energy as a cost of goods and services (COGS) is low – less than 10% -- for the company overall, but exposure is high at this facility.
Summit built a diesel purchasing plan based on market intelligence and dialogue with the client. At a corporate level, this was a rolling, six-quarter, range-bound layering strategy. At this site, because of steady volume requirements and purchasing limitations, Summit recommended purchasing fuel in larger, less frequent layers. This strategy was based on the company’s existing corporate risk management strategy; site-specific conditions and contract limitations; price probabilities for diesel/heating oil contracts; and fundamental risk and technical analyses.
In January 2010, Summit’s risk management strategy indicated coverage should be acquired for up to six quarters out --through mid 2011. The site only had 80% coverage through May 2010. The expected site volumes for remainder 2010 and 2011 were being updated, and the site was expecting higher usage than contracted. Summit’s price forecasts showed a price appreciation throughout 2010 and expected the situation to tighten despite global economic uncertainty. The technical analyses in early/mid January pointed toward a brief price retreat. Summit recommended the company wait a couple of weeks for the price correction, but be ready to fix contracted volumes with physical supplier . In February, prices pulled back and Summit recommended that the company fix its price at market. Diesel was purchased at 80 % of coverage at the fixed price of $2.12/gallon for June 2010–May 2011. Summit’s strategy aligned with the company’s corporate risk strategy and achieved cost certainty for a site with high energy as COGS.