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NGL - Risk Management Term: Hedging and Speculation
This section makes the distinction between Hedging and Speculation.
While the potential rewards from speculation may be high, so are the risks. Imagine, for example, you buy a quantity of propane at a fixed price for delivery at some time in the future. Due to the volatility of energy prices, the value of that quantity of propane may have changed before you take delivery of the volume that you purchased.
A speculator, for example, may take the view that the price of propane will rise in the future and therefore feel that current pricing presents an opportunity to 'buy low' today and 'sell high' in the future. Sometimes he will gain and sometimes he will lose (i.e. prices may drop, forcing him to sell and/or use the volume of propane at a price lower than what he paid for it). Speculation always involves a gamble as to where one thinks prices will be in the future.
Conversely, if this same quantity of propane has already been sold on to customers for future delivery at a fixed price then this pair of 'back-to-back' transactions would represent a hedging activity, matching the exposure to price volatility on both the 'supply' and 'demand' sides of the business.
In this section
NGL - Risk Management Term: Hedging and Speculation
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