Hedging Against Rising Gasoline Prices using Gasoline Futures

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    The Best Binary Broker 2020!
    Perfect For Beginners!
    Free Trading Education!
    Free Demo Account!
    Get Your Sign-up Bonus Now!

  • Binomo
    Binomo

    Good Broker For Experienced Traders!

LINN Energy As A Way to Hedge The Rising Price of Gasoline

Virtually anybody who reads the financial news or drives a car knows that the price of gasoline has surged lately. This has undoubtedly had an impact on the wallets of many American consumers including, quite possibly, many of you reading this.

Fortunately, there are things that we can do to mitigate the impact that rising gasoline prices have on us as end consumers. One way to do this is to invest in stocks that are likely to rise with the price of gasoline. For example, large oil companies such as ExxonMobil , usually have stock prices that are at least somewhat correlated with oil (and gasoline) prices.

Another way to protect yourself against rising gasoline prices is to buy units of an upstream MLP. These investments have the advantage of paying relatively high distribution yields that can be used to help cover your costs of purchasing gasoline. One such MLP is LINN Energy .

About LINN Energy
LINN Energy is a member of a relatively small group of publicly traded oil and gas partnership. The company purchases known productive, and usually mature, oil and gas properties with the intention of extracting the oil and gas from the ground, selling it, and sending as much of the profit as it can to its unitholders.

It usually targets properties with a low and known depletion rate so that management has a fairly reasonable idea of how much cash flow the property containing the well will generate in advance. It has been fairly successful at this and has paid a quarterly distribution to its unitholders for 27 consecutive quarters up until the end of 2020. Beginning in 2020, LINN Energy began to use a different payout schedule and currently pays its distributions monthly .

Declining Unit Price
Linn Energy’s unit price has fallen precipitously since mid-February despite the strength in oil prices over the same period. This could present an opportunity for Foolish (not foolish with a small “f”) investors to jump in. First, let’s have a look at the magnitude of the decline. Here is the chart for LINN Energy over the past six months:

Source: Yahoo Finance

The reason for this rapid fall over the past month is that it suffered from a wave of downgrades as Jim Cramer , Howard Weil , and JP Morgan downgraded the stock. The reason for the downgrades is pretty much the same among all three parties. Basically, they are concerned that LINN Energy will not generate enough distributable cash flow to cover its per unit distribution this year .

Admittedly, these are certainly valid reasons to be concerned. After all, if LINN Energy does fail to generate enough distributable cash flow to cover its planned distributions then the company will either have to cut its distribution, take on debt, or dilute the existing unitholders by selling more partnership units in order to raise the money to make its planned distributions to the unitholders.

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    The Best Binary Broker 2020!
    Perfect For Beginners!
    Free Trading Education!
    Free Demo Account!
    Get Your Sign-up Bonus Now!

  • Binomo
    Binomo

    Good Broker For Experienced Traders!

Reasons for Possible Difficulty
The reason for the concern surrounding LINN Energy’s ability to make its distribution payments is due to the company’s operations in the Permian Basin. These assets, which LINN Energy acquired last year , are somewhat outside of the company’s core strategy because they require horizontal drilling techniques to access the oil located in them instead of the more conventional vertical drilling techniques that LINN Energy is normally able to use on its properties.

Unfortunately, horizontal drilling is much more expensive than vertical drilling. To address this, LINN Energy is looking to sell these assets outright or trade them for more mature assets that are better aligned with the company’s core competency to operate. If it is successful in doing this, especially in obtaining the asset trade, then it should be able to reduce its capital expenditures and thus increase its distributable cash flow.

Company Can Use Hedging to Lock in Revenue
One of the advantages of LINN Energy’s core strategy of purchasing mature oil and gas producing properties with stable decline rates (Permian assets notwithstanding) is that it can fairly accurately predict its production in any given year. This allows the company to lock in a sale price in advance for the majority of its production, which greatly helps the company to predict its revenue in a given year.

LINN Energy has done exactly this and has secured sales prices for all of its expected natural gas production from now until 2020 and all of its expected oil production this year. The company has also locked in prices for 50-60% of its expected oil production in 2020 and 2020 . This practice is known as hedging. By hedging its production and locking in oil prices, LINN Energy has effectively protected itself against a revenue decline should the price of oil and gas go down. Unfortunately, LINN Energy will also not benefit as much from the entire increase in oil and gas prices should they rise further than expected.

High Distributions
Speaking of the company’s distributions, LINN Energy pays a high one. At the time of writing, LINN Energy units trade hands for $28.34 and the company pays an annualized distribution of $2.90 per unit. This gives the units a very high distribution yield of 10.24%. Although there is some risk that the company will not generate sufficient cash flow to cover this distribution and may have to cut it as discussed above, that risk certainly appears to be baked into the price at this level.

How does LINN Energy stack up to some of its MLP peers?
Record oil and natural gas production is revolutionizing the United States’ energy position. Finding the right plays while historic amounts of capital expenditures are flooding the industry will pad your investment nest egg. For this reason, the Motley Fool is offering a look at three energy companies using a small IRS “loophole” to help line investor pockets. Learn this strategy, and the energy companies taking advantage, in our special report “The IRS Is Daring You To Make This Energy Investment.” Don’t miss out on this timely opportunity; click here to access your report — it’s absolutely free.

Daniel Gibbs has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 – 2020 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

How to Hedge Against Gasoline Price Increases

This article/post contains references to products or services from one or more of our advertisers or partners. We may receive compensation when you click on links to those products or services.

When gasoline prices at the pump increased to the point where the cost was a major news item engendering backlash among the public, oil companies were sporting big profits. Consumers reacted by buying more fuel-efficient cars and traveling less, but there is another approach for investors — an approach that mimics what commodities and hedge fund traders do. There are a few suggested approaches, but some work better than others.

One approach is to simply buy stock in the companies that are increasing prices to hedge against cost increases. The theory is that if prices of consumable goods increase to drive profits for the company, owning part of the company will turn those higher expenses to investment returns.

A quick check of gas price data and Exxon Mobil’s performance shoes that stock prices don’t always correlate with an increase in gas prices, but Exxon Mobil did provide dividends to investors during the last major period of gas price increases, from December 2008 to now. Investors during this time would have received $5 per share in dividends. If you estimate you’ve paid $5,000 more in total gasoline costs since December 2008 than you would have if gas had remained at $1.70 per gallon — and this is an assumption I’ll continue to use here — it would have taken 1,000 shares of XOM to earn that back in dividends. Those 1,000 shares would have cost a total of $80,000 in December 2008 and they’d be worth only $72,000 today.

This strategy would not have been very efficient. What about industry ETFs? The United States oil ETF, USO, would have seen performance not quite as bad as XOM over this period, but there would be no dividends. Investing directly in companies that profit from higher prices does not seem to be a winning strategy.

A bunch better choice would be an ETF that tracks gas prices closely, regardless of the stock performance of the companies involved with delivering gas to the consumer. Over this time period from December 2008 to today, UGA, an ETF that takes this approached, has increased 130%. Gas prices increased from about $1.70 to about $3.60 per gallon, or an increase of 111%. This seems to be the better approach for hedging against gasoline price increases. From an absolute dollar perspective, earning back the $5,000 in additional gasoline expense over this period would have required an initial investment of $3,850, a more reasonable down payment.

There are other ways to hedge gas prices, like selling put options on UGA. If you’re willing to gamble that UGA will trade at a certain minimum price on a certain day in the future, you can take a profit to help offset your gasoline expenses. If you take that bet and UGA is not trading at that price, you could lose money on the trade, but you’d be paying less at the pump, so you’ve saved money anyway. I think buying the ETF is a better idea for most investors than dealing with options.

Another option, in combination with investing, is to ensure you’re getting the best prices for the gasoline you buy. It doesn’t make too much sense to drive out of your way to get to the isolated station with the lowest price, but be aware of your options. Find the best gas credit card for you and use it to earn cash back, but be wary of stations that charge different prices depending on whether you use cash or credit.

If you are planning to buy a new car, consider cars rated with high gas mileage. The effects of these ratings aren’t linear; a 5 MPG upgrade from a 15 MPG vehicle to a 20 MPG vehicle has more of an effect on your finances than a 5 MPG upgrade from a 35 MPG vehicle to a 40 MPG vehicle, but it’s clear that a 40 MPG vehicle, while slightly better than 35 MPG, is a significant improvement over 15 MPG. Efficiency has its own environmental benefits beyond the cost of fuel, so some people may feel it’s worthwhile to buy fuel-efficient cars even if the higher prices make overall cost savings (including car price and gas) harder to achieve.

Right now, gas prices may not be the biggest financial concern for a family. The public now expects high prices despite not too long ago bemoaning when prices climbed above $1 per gallon. Transportation can be a significant expense for a family, though, particularly in locations where the career economy is based mostly on commutation, like New Jersey and California.

How do you build a successful strategy to hedge fuel prices with options on gasoline futures?

a qTmJK d h M b lw y FSisq s R qa a cG g r i oM n AgD g YbQd gFqT B pN u j l xUR l Qh , by EqKNX L v L Lef C RDCc

Pricelock provides a web-based tool to help businesses do exactly this (lock in a price on a number of gallons.)

There’s some helpful info on the site that talks about some of the strategic elements to keep in mind:

The important thing to think about is correlation between what index you use to hedge and your local gasoline prices. For example, prices in California tend to vary a lot from prices in Kansas – so an index thats appropriate for one location might not be at another.

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    The Best Binary Broker 2020!
    Perfect For Beginners!
    Free Trading Education!
    Free Demo Account!
    Get Your Sign-up Bonus Now!

  • Binomo
    Binomo

    Good Broker For Experienced Traders!

Like this post? Please share to your friends:
How To Do Binary Options Trading?
Leave a Reply

;-) :| :x :twisted: :smile: :shock: :sad: :roll: :razz: :oops: :o :mrgreen: :lol: :idea: :grin: :evil: :cry: :cool: :arrow: :???: :?: :!: