Richard Larkin : Hedge Solutions , Inc .

Founder and president of Hedge Solutions , Inc ., can be emailed at rlarkin @ hedgesolutions . com . Hedge Solutions ’ website is www . hedgesolutions . com . Larkin also founded Northland Energy Trading , which provides customized hedging products , and he created Hedge Insite , hedging software for fuel oil and propane companies .

It feels like I ’ m always apologizing for bringing up the latest , oft mentioned morpheme , basis blowout . So often that a client of mine once threatened to create T shirts with a picture of a grenade and BASIS BLOWOUT emblazoned underneath it and then drop them in my trade show booth with a For Sale sign .

Alas , here I am again writing ad nauseum about this phenomenon that has caused so much anxiety for us lately . For years we have taught or advised our clients around the much-ignored advantage to managing the subtle nuances around the basis equation . We showed where understanding these incremental spreads in basis could significantly knock down the option “ spend ”. We typically trained most of our attention on the risk of basis widening out and even at that it was limited to certain months in the winter .

Now , thanks to a number of factors that are impacting the supply chain and logistics , this risk is not so subtle , and it cuts both ways . Managing basis risk in today ’ s marketplace is hugely critical to the success of your hedge program . It is essential to your profit margin . And if mismanaged , or ignored , it can wipe out your profit margin . Appropriately , it has moved front and center to any hedging strategy and it also commands attention to your daily rack price movements and even supply availability .

I ’ ll start with the industry definition of basis . It ’ s a very simple calculation , however it ’ s important to understand that the term applies to two distinct calculations , or spreads . The first is the spread between the Nymex spot month and the New York Harbor cash price , reported primarily on two platforms or agencies : Platts and Argus . The second , more organic yet equally important calculation is the spread between the Nymex and your local rack .

As I mentioned earlier , the potential for cash market or rack basis to move significantly has always been a factor . However , this risk up until now has always been one dimensional . As hedgers , we only needed to worry about the basis getting wider , or blowing out . We didn ’ t really need to consider the risk of basis contracting , or of the spread shrinking if you will . For example , when hedging a cap program , we could buy wet barrels to cover the entire program and then purchase put options to cover the risk of the price falling , essential to the win-win proposition of a cap . The only concern here was that a warm winter could leave you with too much oil bought . The most common solution was to

balance your strategy with call options , leaving you to go to the rack for this volume . If that volume wasn ’ t there due to warm weather , no worries as you didn ’ t have a promise to your supplier and the customer paid for the option premium through the fee charged .

This simple hedging strategy became a bit more complicated last year . Though it started when Russia invaded Ukraine , there were other issues hanging around that would shift the marketplace away from “ basis norms ”. There isn ’ t enough time or space here to cover all of these factors , but a few would be low inventory cover in PADD 1 ( East Coast ) stocks where the majority of heating oil demand resides . The loss of refining capacity , specifically on the east coast , compounded the problems . Longer term issues that were less visible yet growing in significance was and still is the lack of suppliers bringing product into supply points . Meanwhile , the

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