Tools

MSDS-TDS

NGL - Risk Management - FAQs

A night shot view of a road looking down to the city of San Francisco

Frequently Asked Questions - Risk Management Strategy

1. Which is the best index to use for my Hedge?

This decision is one you will need to take by comparing where you physically lift with the most liquid indexes. The Mont Belvieu (MBV) or Conway (CW) hubs probably represent the most liquid pricing locations for implementing a hedging program, although selection of either of these locations may carry a degree of risk if the purchase prices you experience at your actual local propane location/terminal(s) do not closely follow the "hubs". Historical price charts will assist you in seeing how much difference there has been in the past between your purchase location and the index locations you are considering, although you will also need to consider the possibility of future changes in the price relationship between price levels at your particular purchase location and those at the index location.

You and your organization will need to decide whether you want to trade in highly liquid indexes such as MBV and CW hubs—thus accepting a degree of price risk between the location of the physical lifting and the hub--or to use a more defined but lower-liquidity index quotation such as Sarnia.

2. Are Caps a worthwhile idea when prices drop?

There isn't a 'panacea' solution for all situations. The biggest advantage that caps give to the buyer is that they protect if prices move up above the cap price, but they don't preclude the opportunity to take advantage of dropping prices. This 'protection', though, comes at a cost: a premium must be paid up front for the cap, and this premium will not be refunded even if the cap is not utilized.

Premiums for caps tend to be high, but will be lower when the selected cap price is above the current selling price for the month(s) covered by the cap, the timeframe for the cap is short, and the prices for the selected location are not historically volatile.

3. I did a Pre-Buy last year and ended-up losing $45,000! Why should I bother again, especially with lower spot prices?

The better question is: why did you really enter into a pre-buy last year? Was your objective to make a profit from the pre-buy or was it to hedge your physical position?

Risk Management tools are not necessarily profit-making tools. The justification for utilizing risk management tools should always be based on the needs of the company and a risk exposure that it is facing. Risk Management tools should be used to protect against adverse price moves; they should not be used to attempt to create income unless speculation (with its attendant high risks) has been specifically authorized by a well-informed board that is cognizant of the risks posed and the internal controls required by trading for speculation. Utilization of risk management tools should be part of a strategic decision against a budget target, for example, or their cost should be viewed as an insurance premium.

4. What is a good time to take up Risk Management cover / Hedge?

There is no particular time of the year that is better than any other for entering into fixed-price transactions, caps, etc. It is true that prices do show some seasonal trends; for example, propane prices have traditionally been higher over the northern hemisphere winter, but this has not really been the case in all years—so it doesn't necessarily follow that this seasonality creates better or worse hedging opportunities around this time. It is important for companies to consider, and define, the type of exposure they have to NGL prices, by taking into account their demand patterns, seasonal variations of the trade, and local volatility, and then decide upon the best way to manage that exposure. They should then set objectives or levels they would wish to achieve at any point of time and for a specific volume and time frame ahead.