Rashaan Baskerville

BIO :

Rashaan Baskerville , Senior Director of Angus Finance , has nearly two decades of experience in the financial services and energy services fields . In his role as a fractional CFO for the fuel distribution industry , he helps dealers develop and implement business growth strategies . He can be reached at rbaskerville @ angusenergy . com .

As a fuel dealer , you are very familiar with the concepts of pricing programs and commodity hedging . However , another type of hedging has been gaining traction in recent years and you may have heard it ; it is called weather hedging .

WHAT IS A WEATHER HEDGE ?

A weather hedge is an instrument that allows you to protect against the lost profit impact of a warm winter , like this past season . One example would be a seasonal heating degree day ( HDD ) put option . With this specific instrument , you can define the amount of profit protection that you would like to purchase based upon total HDDs falling below a specified strike level that you can determine .

Because it is a put option , if the total HDDs are above the strike level , you do not receive any payout . However , if the total HDDs are below the strike level , you receive a payout based upon how far below the strike level they fall and how much protection you purchased for each HDD .

TO HEDGE OR NOT TO HEDGE

As you review your options related to weather hedging , you may want to consider your other options for offsetting the profit pitfalls of a warm winter , as well as what other impacts you may face in the current economic environment . Some these key factors are variable cost structure , fixed cost structure , inflation , and interest rates .

• Variable Cost Structure Your variable cost structure includes items like driver payroll ( particularly part time and seasonal ) and service tech payroll that can be reduced with lower levels of business in a warm winter . You will want to estimate the maximum amount of driver payroll expense that could be cut in a warm winter , without losing valuable employees . Then , based upon your forecasted unit margin , calculate the number of gallons represented by the maximum amount of your driver payroll cut . This tells you what percentage decrease in gallons can be offset purely by driver payroll cuts – anything more will eat into profitability .

A similar analysis can be conducted for service tech payroll to determine the amount of revenue decrease that can be offset by payroll cost cutting . However , this area tends to have less flexibility .

• Fixed Cost Structure Your fixed cost structure includes items like overhead payroll , insurance , and rent . These are expenses that do not come down with reduced levels of business in a warm winter . Due to the seasonality of the fuel distribution business , many dealers experience losses in the offseason , even in a normal winter . Therefore , when considering the profit impact of a warm winter , it is important to understand how much can be absorbed in the way of additional losses and still keep up with your fixed costs . This can be done through a detailed analysis of your company ’ s fixed cost structure .

• Inflation Inflation rates have come down significantly after hitting historic levels over the past two years . However , recent measurements of the Consumer Price Index ( CPI ) have remained above the Federal Reserve ’ s ( Fed ) target level . Your costs will continue to rise based upon the CPI levels . So , as prices are rising , inflation must be considered when calculating your company ’ s ability to maintain your fixed cost structure , as well as your ability to purchase fixed assets like computers , vehicles , and steel tanks .

• Interest Rates As of the July 2023 Fed meeting , benchmark interest rates have reached the highest level in more than 22 years . Because inflation rates are still above the Fed ’ s target , it is likely that interest rates will continue to increase . As a result , your company ’ s variable rate debt has gotten much more expensive since March 2022 and it will continue to get more expensive . Calculate the annual impact of this increase based upon current interest rates . This strain on profit and cash flow is only worsened by the profit loss impacts of a warm winter . So , when deciding to hedge or not to hedge , you now know some of the key considerations to take into account . In addition to the quantitative factors above , you will also want to consider your company ’ s willingness and ability to remain consistent , should you decide to implement weather hedging . Make a decision to hedge or not to hedge and stick with it , because simply hedging based on last year ’ s weather does you no good this year .

As with any financial instrument , you should always consult your professional advisors before taking any action on weather hedging . l FON

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