Read Before You Hedge More Fuel

Published on: 10:48AM Feb 11, 2011


I have had a few calls as of late regarding when and how to lock in your fuel cost.  Several producers I have spoken with stated they have never had much luck with using "Heating Oil" to hedge their diesel needs and were wanting to test their hands in "crude oil."  This hedge was of course recommended by their advisor.  I also spoke with several of our speculators who are also considering crude oil and have called in to confirm information their brokers or advisors were telling them about making a play in the Energy "crack spreads."  They are being told that the crack spreads have traded out to a record level and are screaming that it should be taken advantage of.  I strongly urge you not to listen to this advise and stay on the sidelines, do not get pulled into this mess.  I can not guarantee it, but from what I hear, there is a massive "inside job" taking place.  This is certainly larger than you and I, and something that I promise, you want no part of.  To bring everyone up to speed you have to first understand all of the variables.  To start, let's look at the "crack spread."  The crack spread is an indication of the profit margin available from refining crude oil, and is best defined as the price of two gasoline futures contracts, plus one heating oil futures contract, minus three WTI crude oil futures contracts.  Essentially traders will go long (2) Unleaded Gasoline contracts, long (1) Heating Oil contract and off-set it all against (3) short WTI Crude Oil contracts.  However, as of late, the "crack spread" has been surging to extreme levels.  In normal conditions, the increased crack spreads' premium would signal that refiners are making big profits by buying oil relatively cheaply and then processing it into expensive fuel (gasoline and heating oil).  What everyone is failing to notice is that the price refiners are paying for their oil is much more than Nymex "WTI" crude oil futures contracts are suggesting.  This means the big profits seen in the crack spreads are all just smoke and mirrors. One of the main reasons the spread has gotten out of whack is because of the games that are being played with the Nymex West Texas Intermediate (WTI) crude oil contracts.  You need to understand that "West Texas Intermediate" (WTI) crude oil is of very high quality.  Its API gravity is 39.6 degrees, which makes it a "light" crude oil, it also only contains about 0.24 percent sulfur, which makes it a "sweet" crude oil.  On the flip side the Brent Crude Oil Blend is actually a combination of crude oil from fifteen different oil fields located in the North Sea.  It is still a "light" crude oil, but not quite as "light" as WTI, and it contains about 0.37 percent of sulfur (making it a "sweet" crude oil, but again slightly less "sweet" than WTI).  As you can imagine, WTI crude oil should be more expensive then Brent Crude Oil.  Right now, that is not the case.  In fact, Brent crude oil has traded out to an almost $17 premium to WTI crude oil as of late.  It is my belief that some type of major market manipulation is underway, and the recent political tensions in the Middle-East has given them an opportunity to make their move.  Think about it this way, our US gasoline inventories are reported at the highest level since March 1990 (yet gas prices are going through the roof) and our "distillate" inventories (which include heating oil and diesel fuel) are even more burdensome.  All at a time when prices at the pump are surging, and WTI crude oil prices are falling.  How is it that crude is falling but Gasoline is surging?  Something doesn't add up.  I am telling you now the refineries are not making huge profits as you might be lead to believe, instead they are being forced to buy the much more expensive Brent crude oil, leaving the WTI contract out in the cold.  The massive divergence in price the past three weeks has wreaked havoc on energy investors, traders, fund mangers, etc...  If you dig deep enough, I believe we can trace it all back to 2009 when Saudi Arabia, out of the blue decided to drop WTI crude oil as its benchmark for pricing oil to US customers.  The Saudi's claimed they wanted to shift away from the WTI contract because there were too many speculative swings.  In hindsight, that was all one big lie.  Remember, WTI crude oil is the world’s most liquid oil futures contract, for years has been called the only "real" price of oil.  Within the past two years, the Suadi's have convinced others, such as Hugo Chavez to join their campaign and drop the WTI benchmark for sales of crude oil to America.  In its place they started using what is called "Argus Sour Crude Index" (ASCI), which measures heavier oil with higher sulfur content (in essence crappy crude oil).  There is no debating the fact that Argus Sour Crude is inferior to WTI crude, and should always trade at a discount.  Well it is not, in fact it is trading significantly higher than WTI crude.  This essentially means the US is allowing Saudi Arabia, Venezuela and a handful of others to sell us here in the US an inferior product while we pay a premium price for the "crap" Argus and Brent crude blends, while the Saudi's and others turn right around and sell their quality crude for a massive premium to China and select areas of Europe.  I am not exactly sure why we are allowing this to happen, but I am sure we know what is going on and in some way, shape or form have orchestrated the move.  I don't want to believe this but, I am starting to hear rumors that the US has strategically placed the WTI inventories and stocks in Cushing, Oklahoma in order to make supplies tougher to get from the coast, this encourages refineries to use the Brent or Argus blends rather than the WTI.  This means inventories of WTI build and prices drop.  These WTI prices are then used to calculate inflation rates and other government data here in the US.  All the while we are paying more at the pumps and refineries are paying more for the imports and to the Oil gods in the Middle-East.  We are feeling the pain, but the government continues to point to data that shows figures on inflation not really rising by using the WTI crude oil prices.  Nothing in the numbers reflect the recent prices of Argus or Brent Crude, the real benchmark prices being paid.  I would not encourage my worst enemy to get caught up in this mess or to jump in any type of trade right now in WTI Crude Oil, something is just not right.  I have learned a long time ago if it looks like a duck, walks like a duck, you know the rest....then it is a duck! 

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