Author Topic: Oil ETC offsetting risk in central heating with oil  (Read 532 times)

BobTheBuilder

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Oil ETC offsetting risk in central heating with oil
« on: December 01, 2018, 08:24:34 AM »
Hi all,

I wonder what your thoughts on the following risk-reducing strategy for people with oil for central heating are.
My parents live in their own house, which has a 5000L (1300 gallons) tank for heating oil.

They have to do market timing with respect to when to order, and how much to fill up (bare minimum makes risk of running out of oil when demand is high real)
Heating oil will never be without charge, but might go up like crazy if something goes wrong between supply and demand, but you have to have some.
The risk/reward here looks to be asymmetric.

So if they were to buy an ETC for heating oil covering their usual consumption, they would have zero price risk.
If the price goes up significantly, they could sell (part of) the ETC to cover the increased cost, or do nothing if it is not too much.
If the price goes down, they could fill up the tank as desired and not touch the ETC.

Am I missing a major upside or downside here?
To me, this kind of anti-speculation only makes sense when you actually use the stuff your ETC covers.
Of course there will be opportunity costs in putting around 2K euros on the side line, because I do not think that commodities are and investment after inflation. They may fluctuate strongly, but are not productive themselves.
Also for buying and possibly for selling. That may be viewed as an insurance premium.

Are there more efficient ways of having the same result than buying ETCs? What are your thoughts on oil stocks for this purpose?

jjcamembert

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Re: Oil ETC offsetting risk in central heating with oil
« Reply #1 on: December 04, 2018, 04:36:14 PM »
I don't really have any experience using commodities as a hedge, but I have been interested in the concept so here's an article I found:

http://www.theoptionsguide.com/heating-oil-futures-long-hedge.aspx

However, since your parents only require 1300 gallons and not the 42,000 gallons a futures contract would carry, I don't know that it's worth the trouble hedging with 3% of a contract. You could get that by selling a tight put spread / buying tight a call spread, but the next problem is very little liquidity in those contracts, so it might not even be possible without losing a good chunk on the fair value.

I don't know much about ETC's but you'd need to figure out the ETC's exposure to heating oil per share; i.e. how much would you need to buy to offset the risk but not get overexposed to HO. Same with oil; crude oil and heating oil are very correlated in the long run, but as you approach the time when they'd want to buy physical heating oil they'd be exposed to much more correlation risk; i.e. the spread between CL / HO might be larger than when they first purchased the oil hedge.

You're right that the opportunity cost is buying a 1 year CD or something for next year, and if HO prices drop as well you've made more money than if you had bought the hedge.

Given all that, and that it's only 2k EUR, I'd probably just buy the CD. There may be companies as well that sell commodity insurance and hedge themselves with futures.

BobTheBuilder

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Re: Oil ETC offsetting risk in central heating with oil
« Reply #2 on: December 06, 2018, 03:01:01 PM »
Thank you for the input!

If something exciting happens at some point, I might give an update. Its a special topic and for most mustachians the amount of money at stake is not that impressive, but for people not used to having cash to spare it might still make a difference.