Heating Oil Hedging, Explained

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March 2019 /

The year was 1978 and I was a newly-minted bank lending officer at Irving Trust Company in Manhattan. Fresh out of high school and desperate for any type of recognition, I volunteered to join a small group of adventurers involved in introducing a futures contract on the New York Mercantile Exchange (the Exchange) to local heating oil dealers. For the uninitiated, the Exchange opened in 1872 as the Butter and Cheese Exchange of New York. It was founded by a group of dairy merchants trying to bring order and standardization to the chaotic conditions that existed in their industry.

Fast forward to 1978 and there I am with securities broker Emmett Whitlock of Paine Webber and Arnold Saifer, the senior economist of Irving Trust Company, on the way to a meeting of the Long Island Heating Oil Dealers Association. We are shoehorned into Whitlock’s unheated two-seater Studebaker in the dead of winter on the way to Port Jefferson. Forty years earlier, according to my family folklore, my father’s uncle, John Spurga, had made this very same trip and went from Lithuanian immigrant to entrepreneur, opening Spurga’s Department Store and then parlaying that into a local community bank. Eventually the winters became too much for John, so he packed up and bought orange groves in Cocoa, FL, which he later sold to the government, who then went on to transform the groves into Cape Canaveral.

I’m in the rumble seat of the Studebaker with my personal family history and the history of the Exchange all jumbled together. Should I tell the Heating Oil Association about my Uncle John—should I tell them how the heating oil market has since evolved?

After all, the No. 2 heating oil contract goes back to the year 1974, when the Exchange launched a fuel oil contract requiring Rotterdam delivery but ultimately failed, as the cost of shipping the oil across the ocean varied wildly. In 1978, the reconfigured contract now had its delivery point as the more suitable New York Harbor and eventually found acceptance. While the Exchange had some prior success trading currencies, the impetus for relaunching heating oil was that the Exchange’s other futures contract, the potato contract, had been over-traded by speculators, threatening the very existence of the Exchange. There was nothing left for the Exchange to do but relaunch the heating oil contract as a last resort. Actually, there were two contracts launched: one for No. 2 heating oil used to heat residential homes, and another for No. 6 used to heat commercial buildings.

Meanwhile, the three of us had reached our destination and began to preach the heating oil gospel. We said to the assembled dealers: Imagine you are a building owner and you want to ensure that your fuel costs do not exceed your budgeted fuel price, so you want to fix the price of your anticipated fuel consumption which, for argument’s sake, is 42,000 gallons of fuel oil slated for October of this year. To hedge your exposure, you purchase one October No. 2 oil futures contract (since replaced in 2013 by a lower-sulphur content ULSD contract discussed below). Continuing with our illustration, come September 28, the expiration date of the futures contract, you sell back the futures contract at the then prevailing market price. If the futures price at that point is greater than when you originally bought it, the gain on the sale will offset the increased cost (over your budgeted cost) you pay when you actually purchase the 42,000 gallons from your regular suppliers. The reverse is true if the futures contract is sold for less than what you paid for it—the loss is offset by the reduced price since you are now paying less for the 42,000 gallons from your regular suppliers. What you make or lose on the physical sale is offset by what you make or lose on the sale of the futures contract.

Even though things didn’t look great at first, the three of us continued to trek to heating oil association meetings in Whitlock’s cramped Studebaker. And our message was finally getting through. The heating oil contract went from a minuscule 10,000 barrels a day in November 1978 to 95,000 barrels a day in August 1979. Others took notice, and soon a West Texas intermediate crude oil contact was introduced, which was quickly incorporated into the trading portfolios of the major oil companies. And the No. 2 heating oil contract was officially replaced by the lower-sulphur content ULSD contract in April of 2013 in response to demands by environmentalists.

Still, I will always remember the three of us tooling around Long Island in the dead of winter in that cantankerous automobile, like three modern-day Don Quixotes in pursuit of an impossible dream.

But, in our case, I’m sure we made Uncle John proud.

Ron Spurga
United Metro Energy Corporation
P: 718-389-5800 ext. 191
ron@umecny.com

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Ron Spurga By Ron Spurga

Ron Spurga

Ron Spurga

Best-selling financial author, Wall Street investment banker, social commentator, award-winning poet, energy consultant, off-Broadway producer, and community organizer in Robert Kennedy’s presidential campaign, Ron Spurga is the ultimate Renaissance Man.

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