Richard Larkin

Hedge Solutions, Inc.

I know, I know! You’ re tired of reading and talking basis blowout! Relax, I’ m not here to discuss blowouts at the rack. Basis is the standard expression for the relationship between two indexes in a commodity. In this case it’ s the spread between the spot ULSD contract on the CME exchange and your local supplier’ s rack price. This spread, the so-called basis, is a critical piece of information in the rack equation needed for negotiating a supply contract or a wet barrel for hedging. It is also important to understand the basis when buying oil.

If you are not monitoring and learning the basis relationship in your oil purchasing, you are likely missing opportunities to improve what I call your purchasing score. The purchasing score, simply put, is a grade on how well you are doing in managing your oil buying these days. We’ re not talking about fractions of a penny here. We’ re talking whole pennies per gallon. This can be a significant number you are leaving on the table. I can make a solid case for this data having as much impact as any other metric you might be tracking in your business.

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THE SAFE CHOICE FOR BIOFUEL BLENDS

There are 3 critical areas you should be looking at regarding the basis relationship.

• Hedging: Wet barrels or paper hedging

• Supply contracts

• Spot purchases

All three areas are simple to monitor and track. You can do it on a spreadsheet. You’ ll want to record the following every day: the spot month settlement of the ULSD contract, your low rack price, your daily sales volume and the retail price. This task should not take more than two minutes and should be sourced to an admin person; NOT you( as the owner / manager you wear too many hats and will never keep it up). This ensures that it gets done every day. I highly recommend that you also record every one of your suppliers’ prices, including any spot deals offered. The more that this data ages out the higher the value; likely reaching a plateau at about three years.

THE IMPORTANCE OF BASIS TO HEDGING STRUCTURES.

Since it’ s that time year when there’ s a lot of hedging going on for the price protection programs next heating season, let’ s start here.

Let’ s say you are hedging a cap program. There are basically two structures for hedging a cap price. You can buy wet barrels and put options, or you can buy call options. The call option covers any increase in the price while the downside component is realized at the rack. In the other structure, the wet barrel contract covers any increase in the price while the put option is used to pay off any downside risk. They both perform the same task, so why choose one over the other? This is where the basis comes in. Let’ s say you are looking at covering the month of December’ s gallons and are offered a wet barrel contract priced at. 10 / gallon over the December futures contract. Before you take that offer, you review the rack basis data over the past 3 years for December and find that the average spread is. 02 over the spot contract. That’ s a whopping. 08 per gallon more than you are paying for the privilege of buying a wet barrel contract in advance. Instead of buying a wet barrel with a put option you opt for buying the call option knowing that your rack basis is averaging just. 02 per gallon. This hedging structure will lower your COGS significantly. This scenario plays out time and again in almost every marketplace. The wet barrel contract typically demands a premium from the supplier. And for good reason; sometimes. The supplier, who must turn around and hedge the wet barrel contract on paper themselves, is also tasked with carrying the margin requirements on your behalf for the time between the day you lock the prices in and the actual delivery months. Does this mean you should not use the wet barrel / put option structure in any part of your strategy? No. The wet barrel / put option hopefully offers you supply certainty and basis certainty. However, when over utilized it can add up significantly. Pennies per gallon in most cases.

14 JUNE 2025 | FUEL OIL NEWS | www. fueloilnews. com