Lock in low gas prices?

[Htown Harry]

I saw an article last week that suggesting an individual could take advantage of the current cheap gas prices by buying an exchange traded fund that tracks gasoline futures. If gas prices go up, the fund value also goes up, covering the extra cost of buying the gasoline.

Locking in Low Gasoline Prices

The idea is nothing more than a commodity hedge transaction structured around family gasoline purchases. Buying futures has been around for centuries and the big boys at Megacorp do it all the time as a way to lock in their costs of production.

But A does not equal B in this case. While I am fairly confident that gas prices will be rising in the future, I know we are a low mileage family. This makes it somewhat improbable that we would be able to overcome the hit caused by high transaction fees. Nonetheless, I ran some 3-year numbers that were somewhat attractive.

I calculated that I would reach breakeven if gas prices rise to create a three-year average that is about 20% higher than today's price.

On the other hand, if prices are flat in 2009, rise by half in 2010 and rise a similar percentage in 2011, I could save about $1000 over the three years. If gas prices stay flat, my loss would be less than $500.

To be consistent with current financial practices, I didn't calculate a scenario where the price actually goes down.

To reduce uncertainty, I could spend hours developing a multi-page spreadsheet for every scenario, then ask the energy trader living next door to check my numbers. But it is so much more fun to toss out a fad money-saving idea to the ER Forum's financial experts.

Here's my envelope. YMMV....(Sorry. I couldn’t resist.)

Let’s say my family’s total miles are 250 per week, 1000 per month, 12k per year. (Assumes two weeks per year with no driving.)
Our vehicle gets 20 mpg, so our consumption is 12.5 gallons per week, 50 gallons per month, 600 gallons per year.
At $1.50 per gallon, our current expense is $18.75 per week, $75 per month, $900 per year.
If gas prices rise 50%, to $2.25, the annual cost will be $1200.
If gas prices rise to $3.50 the following year, the annual cost will be $2100.
If that’s what actually happens over the next three years, then my total expense will be the sum of those three numbers, or $4200.
But I want to hedge at today’s prices, or 3 x $900 = $2700, creating a nominal savings of $1500.
The actual savings will be reduced, however, by my loss of use of the money I prepay (the time value of money…) and by my transaction expenses.
Transaction cost: for the hedge to “work”, I’ll need to sell the hedge periodically. This could be as frequently as monthly, on the day when my credit card bill is paid. But I’ll pick quarterly to reduce my transaction costs.
My broker charges $10 a trade, so my transaction expenses over the 3-year period will be (3yrs x 4 sales/ yr. x $10 = $120 sales expense) + (my $10 initial purchase expense) = $130.
I’ll figure a 4% interest rate, which is about what a 3 yr. CD is paying. I will therefore be giving up about $350 in interest if I bought a $2700 3 yr. hedge instead of a 3-yr. CD.
So my total cost is $2700 + $130 commissions + $350 “lost” interest = $3180.
Comparing this to the $4200 cost of the fuel I will consume, I’ve saved $1020!
The savings are that good in large part because I’ve assumed there will be a big price jump. It may not actually rise that much, of course. And if prices stay flat or rise only modestly, I will lose money or break even on the hedge.
I can figure my breakeven point by finding where my expenses of $480 ($350 + $130) is offset by a like amount of price escalation.
This calculates out at $2700 + $480 = $3180. Dividing, I figure I will break if the price of gasoline rises such that the average price over the next three years is 17% more than today’s price (3180/2700).

I’ve ignored the fund’s management fee, but if it is 2% the breakeven calculation would only vary by about that same amount.

Are my numbers in the ballpark?

Any thoughts on the scheme in general?

[REWahoo]

Originally Posted by Htown Harry

Any thoughts on the scheme in general?

Harry, here's a thread from last week on the same subject: Hedging fuel price increases

I threw away my spreadsheet calculations and bought a little USO based entirely on psychological and emotional reasons. Now I can be happy if fuel prices stay low and happy if they don't. Created my very own win-win situation.

[Dawg54]

And just a few months ago we were headed to $5/gl. Everything has turned upside down. My oil stocks getting clobbered, but fueling up the suv is easier.

Return to $1 gas? Energy prices evaporate: Financial News - Yahoo! Finance

[2B]

Htown Harry,

How do you hedge for j*b and real estate losses when oil hits $25?

I suspect things will start getting ugly real soon. My employer has started "selective RIFs." I am in the process of being moved from a cancelled project that needed $70 oil to be viable to an environmentally required project with another client. This will keep me busy until summer.

There were 8 process engineers on the original project and 2 were sent into the void. There are rumors that this will be happening a lot across all disciplines as projects are "reorganized."

There was a comment made by my process lead that there is a person on the new project that I will be "replacing." I met with the process people for this project and nobody said anything about anyone leaving. I suspect I saw a "dead-man walking" but can't be sure.

I was amazed because I found out 2 different projects asked for me when it was known the original project was being cancelled. I have intentionally been a moderate slacker since I started. I'm not particuarly worried about being "force retired." I just don't see what I'd do "retired" in Houston since we can't move or leave for months at a time at this point.

DW and I have our house on the market. I was hoping to downsize and become a renter before the crap hit Houston. It's too late for that so we're probably stuck in the oversized money pit for the duration.

[FIREdreamer]

Originally Posted by 2B

Htown Harry,

How do you hedge for j*b and real estate losses when oil hits $25?

I suspect things will start getting ugly real soon. My employer has started "selective RIFs." I am in the process of being moved from a cancelled project that needed $70 oil to be viable to an environmentally required project with another client. This will keep me busy until summer.

There were 8 process engineers on the original project and 2 were sent into the void. There are rumors that this will be happening a lot across all disciplines as projects are "reorganized."

There was a comment made by my process lead that there is a person on the new project that I will be "replacing." I met with the process people for this project and nobody said anything about anyone leaving. I suspect I saw a "dead-man walking" but can't be sure.

I was amazed because I found out 2 different projects asked for me when it was known the original project was being cancelled. I have intentionally been a moderate slacker since I started. I'm not particuarly worried about being "force retired." I just don't see what I'd do "retired" in Houston since we can't move or leave for months at a time at this point.

DW and I have our house on the market. I was hoping to downsize and become a renter before the crap hit Houston. It's too late for that so we're probably stuck in the oversized money pit for the duration.

I am guessing that, if you live in a city and work for an industry that thrive when oil prices are high, you could be hedging your job and RE losses by shorting oil. Of course it's a bit late now for that...

I personally live in a city which is very dependent on defense spending (and the value of our home is somewhat tied to it too), so maybe I should short a bunch of defense contractors? I cannot think of any obvious ways to hedge our jobs. RIFs in our industry were popular when the economy was booming and there are still popular now...

[ziggy29]

Originally Posted by REWahoo

I threw away my spreadsheet calculations and bought a little USO based entirely on psychological and emotional reasons. Now I can be happy if fuel prices stay low and happy if they don't. Created my very own win-win situation.

That was my thought when I bought USO in July. Wow, did I take a haircut on that one.

But now that I sold it a while back, it should be safe for others to go back into it...

[Alan]

Originally Posted by 2B

Htown Harry,

How do you hedge for j*b and real estate losses when oil hits $25?

I suspect things will start getting ugly real soon. My employer has started "selective RIFs." I am in the process of being moved from a cancelled project that needed $70 oil to be viable to an environmentally required project with another client. This will keep me busy until summer.

There were 8 process engineers on the original project and 2 were sent into the void. There are rumors that this will be happening a lot across all disciplines as projects are "reorganized."

There was a comment made by my process lead that there is a person on the new project that I will be "replacing." I met with the process people for this project and nobody said anything about anyone leaving. I suspect I saw a "dead-man walking" but can't be sure.

I was amazed because I found out 2 different projects asked for me when it was known the original project was being cancelled. I have intentionally been a moderate slacker since I started. I'm not particuarly worried about being "force retired." I just don't see what I'd do "retired" in Houston since we can't move or leave for months at a time at this point.

DW and I have our house on the market. I was hoping to downsize and become a renter before the crap hit Houston. It's too late for that so we're probably stuck in the oversized money pit for the duration.

My company is downstream from oil so the big drop in oil prices is welcome news, but sales are WAY down and next year's capital investment is down the toilet, even worse than the last 6 months have been. All cost savings and expansion projects are on hold and only essential Safety and Rnvironmental projects are being funded. One of our big 3 production units is coming down in Feb for maintenance and won't be coming back for at least 6 months.

I work in the Project Eng. group and we already have had 5 engineers either leave or retire this last few months and they won't be replaced. No mention of forced redundncies so far but that could change.

[Gearhead Jim]

Originally Posted by ziggy29

That was my thought when I bought USO in July. Wow, did I take a haircut on that one.

But now that I sold it a while back, it should be safe for others to go back into it...

Did you get hit just because oil prices went down, or was there something about the structure of the fund that doesn't work correctly?
My other research suggested that USO was more volatile on the the downside, a 10% drop in oil price produced more than a 10% drop in USO. But that could work to our advantage when prices start up again. What do you think?

[ziggy29]

Originally Posted by Gearhead Jim

Did you get hit just because oil prices went down, or was there something about the structure of the fund that doesn't work correctly?
My other research suggested that USO was more volatile on the the downside, a 10% drop in oil price produced more than a 10% drop in USO. But that could work to our advantage when prices start up again. What do you think?

Heh -- I really don't know, but for everyone here who is long USO, I promise I'll disclose if I ever buy it again so they can run for the exits.

That's me, ever thoughtful of others.

[2B]

I had DBC for awhile. I bought it around February for somewhere in the mid-30s. I couldn't believe oil went up so fast so I sold it around $38. It went up a bit further over the next couple months and then crashed. I liked it because it involved all commodities. I think it can be a useful place for 5% of assets based on the different things I've read. I planned on dollar cost averaging into that level but it took off too quickly. I just watched until I couldn't stand it.

[Darryl]

Bought DBC on 1/02/08 at 32 and sold in March and August at 35 and 38. Currently at 19.70 makes it look attractive but then EVERYTHING looks attractive right now.
I think I may need AA (Asset Allocation) meetings and mentor much like AAnonymous to keep me on track. I'm looking hard at DBC or like item again but current thinking has me in stock or bond and expense control mode. I'm believing both stocks and bonds have outperformed commodities over time. I may revisit this when I move out of accumulation mode and in to retiree mode as a slice of commodities does look logical when defending a portfolio. I'm not a huge gas consumer so moving the portfolio to defend this one line item doesn't look worthwhile.

[Darryl]

oops sorry March and April 35 & 38

[2B]

Originally Posted by Darryl

oops sorry March and April 35 & 38

Our dates are slightly different but the same story. I had about a 15% run up in one month. That just made whistles go off in my head. "Things" don't do that without correcting. I just grossly underestimated how long it would have gone before correcting.