Hedge to Cut Energy Costs

January 8, 2013 09:27 PM
Hedge to Cut Energy Costs

Winter’s the time to lock in cheaper diesel

Some inputs are on the rise, but when it comes to allimportant energy, prices are actually below year-ago levels and the price outlook for producers in 2013 is a buoyant one. Some experts question, however, just how much farm energy you should buy ahead, and in the case of propane, whether you should forward buy at all, given the supply/demand/price outlook.

For David Weitz, however, it’s not only about slashing prices. It’s also about locking in another cost, so he can become more perfectly hedged: crop prices against all inputs. In this way, he can take one more highly volatile variable off the table.

"Two years ago when we began hedging, we beat our budget by 35¢ through hedging diesel," the Pullman, Wash., wheat grower says. "That’s the equivalent of one fulltime salary for us."

This past year, hedging diesel contracts through his co-op rewarded him slightly less, but it was still positive relative to the spot market. It’s OK, however, if he doesn’t beat the spot market every year. "The more ‘X’ factors you can remove from your budget, the better. It’s no longer a floating expense," Weitz says.

Another advantage: He can store only 20% of his annual fuel needs, but through hedging he can lock in fuel without taking delivery.

The more 'X' factors you can remove
from your budget,
the better.

"It’s just like marketing crops," Weitz says, dealing with energy futures and basis. His co-op hedges futures on a New York exchange and a basis through a national cooperative, then offers contracts to growers so it is hedged.

As diesel fuel represents 7% of Weitz’ costs, knowing its cost offers dividends. That reflects a USDA study which found that from 2005 to 2008, expenses from direct energy use averaged 6.7%. Corn and rice have the highest per acre energy costs. Soybeans have the lowest.

Price Advantage. Roger Riggers, a wheat grower in Craigmont, Idaho, has been hedging diesel contracts through his co-op for nearly a decade and it’s put money in his pocket. He first started locking in contracts because of fuel shortages. "Then it became a price advantage," he says. "I got better deals than buying fuel weekly or daily."

Not having sufficient storage, he takes a load from his co-op to his farm daily. Overall, he’s in the positive, saving 15% to 25% off spot prices. It doesn’t work that way every year. Some years he’s saved $1/gal. through hedging, other years not nearly as much. Riggers likes to have his seasonal needs booked by February-March, depending on how heating oil use and thus prices—which correlate well with diesel—are fluctuating on the East Coast.

In most years, farm energy costs—both diesel and propane—are the lowest in the winter and see a spike in the spring, says Justin Fuller, director of refined fuels and pricing, CHS Inc. Fall, however, is typically when the greatest spike occurs.

"We expect to continue to see that this year," Fuller says. "Winter is generally the time to buy as much as you have storage for."

That, barring any negative Middle East news of war or conflict that causes prices to spike, is virtually impossible to predict by even the most astute energy expert. Prices are regional, too. In western North Dakota, in the heart of the energy boom, energy prices are sky-high, and that gets passed on to farmers.

Stock Up on Propane. With natural gas so cheap, an incentive exists to stock up on as much 2013 propane as you have room for, but buying hand-to-mouth for diesel seems to make the most sense through spring right now, says Doug Tiffany, an economist at the University of Minnesota who specializes in farm energy issues. "Propane and diesel have been moving in different directions," he notes.

The stocks of distillates are high, he says; furthermore, the price of crude oil has softened. Also  weighing on the diesel price is the sluggish world economy, Tiffany states.

Natural gas supplies, meanwhile, are extraordinarily high, particularly in the U.S., as more oil fields are developed, but Tiffany doesn’t see prices getting any cheaper. If anything, he says, he sees them getting more expensive as we move through 2013. As a result, he thinks locking in this year’s needs early on makes the most sense. Moreover, if natural gas remains cheap, it may be  used to make diesel, which could increase its cost.

What’s the official outlook? All around good news for farmers. The U.S. Energy Information Administration (EIA) projects domestic crude oil production to increase in 2013 to the highest levels since 1993. Natural gas is expected to increase, from 2012’s price of $2.77 per million BTUs to $3.49 per million BTUs in 2013. In 2011, it was $4 per million BTUs. EIA expects that on-highway diesel fuelretail prices will average $4/gal. in  the fourth quarter of 2012 and $3.83/gal. during 2013.

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