Fuel Hedging

Hedging fixes a price for a volume of fuel over a period, trading away the chance of a lower price to remove the risk of a higher one. It comes in two shapes. A fixed-price or capped-price supply contract with a fuel vendor sets the price of the physical fuel. A financial hedge, such as a swap, cap, collar or futures position, is separate from supply and pays out when the market moves against the fleet, whoever actually delivers the fuel.

Public fleets almost always hedge with a supply contract rather than a derivative. Many states restrict or bar local governments from financial instruments outright, and where they are permitted, GASB Statement 53 requires derivatives to be carried at fair value with hedge accounting available only where the hedge is shown to be effective. The standard’s own illustration is a government hedging its expected diesel purchases with a commodity swap. That accounting is enough on its own to keep smaller agencies out. The practical instrument is a fixed-price or capped contract, frequently reached through a state or cooperative contract, which needs no derivative accounting at all.

The purpose is budget certainty, not beating the market, and confusing the two is how a sound hedge gets called a mistake. A contract that locks in above where the market eventually settles has lost money only if the goal was to buy cheaply. If the goal was to spend what the adopted budget said, it did its job. The exposure is asymmetric in a way worth naming out loud before signing: a council rarely notices the year a hedge saved money and always notices the year it cost some.

The habits that survive that asymmetry are ordinary. Hedge a share of expected volume rather than all of it, so the fleet is never entirely wrong in either direction. Match the term to the budget year the price is meant to protect. Know the cancellation and volume-shortfall terms, because a fixed price on fuel the fleet no longer burns is a liability. And price the contract against where the market actually sits that week rather than where it was when the budget was built.