Simple Strategy to Hedge Against Rising Gasoline Prices.

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JAG's picture
JAG
Status: Diamond Member (Offline)
Joined: Oct 26 2008
Posts: 2492
Simple Strategy to Hedge Against Rising Gasoline Prices.

Hi Everyone,

I wanted to share a simple strategy to hedge against the possibility of rising gasoline prices in the coming years. It involves calculating your future need of gasoline and investing in the US Gasoline (UGA) Exchange Traded Fund. The methodology is as follows:

1) Determine total number of gallons of gasoline that you need over a specific time period.

2) Multiply the total number of gallons by the current price per gallon to find the total projected cost over this particular time period at the current price per gallon.

3) Invest the $ value that you calculated in step 2 into the UGA ETF.

4) After holding the fund for one year (to gain a more favorable tax bracket), make calculated withdraws from your UGA holding to compensate for the higher costs of gasoline.

For example:

1) Lets say that you typically drive 12,000 miles per year, and your vehicle averages about 20 miles to the gallon. You have decided that you want to hedge against rising gas prices over the next 5 years. Based on these criteria, you will use roughly 3,000 gallons of gas over the next 5 years ((12,000 miles per year X 5 years) / 20 miles per gallon= 3,000 gallons)

2) Now multiply 3,000 gallons by the current price per gallon, lets say $2.00/gal, to find your projected cost over the next 5 years at the current price, which in this situation is $6,000.(3,000 gallons X $2.00/gallon= $6,000)

3) Now invest $6,000 in the UGA ETF. At $24 a share, you would buy roughly 250 shares. ($6,000 / $24/share = 250 shares).

4) Hold your position in UGA for a year to acquire a more favorable long term tax rate, and then periodically sell some shares to compensate for the rising costs of gas over the next 5 years.

Essentially this is a market-neutral approach for the gasoline market. If prices rise, you pay more at the pump, but your investment in UGA increases proportionally. If prices fall, you will lose money on your UGA investment, but you will pay less at the pump. In theory, this strategy should allow you to “freeze” the price of gas over the period of time that you choose.

What about capital gain taxes? In my calculations, if you invest in the manner described above, you can pay 20% capital gains tax on your UGA profits and still break even (neutralize your fuel purchases). If you think that you would be in a higher capital gains tax bracket, you should initially buy additional shares to compensate for this additional cost.

Disclaimer: This strategy depends on the UGA ETF accurately tracking the price of gas, which isn’t a given. Also, the nature of Exchange Traded Funds may skew the results in volatile markets. Over a long enough period of time, however, I think these effects would be minimal.

I laid this strategy out rather quickly, so I would appreciate some feedback in regards to the validity of my assumptions here. Thanks for your input.

Jarhett's picture
Jarhett
Status: Silver Member (Offline)
Joined: Nov 21 2008
Posts: 132
Re: Simple Strategy to Hedge Against Rising Gasoline Prices.

This is what exactly major airline carriers like southwest did during the last oil shock, however you need to be careful because you can get burned very easily.  Always have protective stops on your trades to prevent this from happening.  Southwest lost a bunch of money in the 3rd Qtr last year due to falling oil prices, not to less air travel. 

Ready's picture
Ready
Status: Platinum Member (Offline)
Joined: Dec 30 2008
Posts: 917
Re: Simple Strategy to Hedge Against Rising Gasoline Prices.

I am taking a different approach - physical possession. I have well over 1000 gallons of diesel, for example, and when prices are low, I buy at the pump. This method allows me to minimize spikes and make sure I am buying low.

Keeping it fresh is a little difficulty, but once you have it worked out, it is OK. New tanks are not cheap, but can easily contribute less than $1/gal if you do it right. Also, when I have gas delivered to the farm, not only is it cheaper than the pump, it also has the added benefit of dropping the $.17 / gal state tax, so it is about $.25 / gallon cheaper.

To me, it's the same philosophy of holding physical or paper gold.

For what it's worth, you can typically get 275 gallon fuel oil tanks that are being removed due to upgrade of furnace for free or nearly free. A little elbow grease and a couple filters, and you have a physical storage of liquid gold. Check out craigslist.

Best,

Rog

gtazman's picture
gtazman
Status: Martenson Brigade Member (Offline)
Joined: Oct 6 2008
Posts: 48
Re: Simple Strategy to Hedge Against Rising Gasoline Prices.

The UGA ETF sounds like a good idea especially since the price of gasoline is only going to go up.  What is the minimum purchase required?

Jarhett's picture
Jarhett
Status: Silver Member (Offline)
Joined: Nov 21 2008
Posts: 132
Re: Simple Strategy to Hedge Against Rising Gasoline Prices.

It is traded just like a stock, so the minimum purchase required would be one share.  USO is also another ETF that tracks the price of oil.  Personally USO appears to have more upside than UGA, since it seems to track the price of oil a little better.  Also I beleive USO is more mainstream.  Just like more people trade GLD for gold rather than IAU.

RNcarl's picture
RNcarl
Status: Gold Member (Offline)
Joined: May 13 2008
Posts: 382
Re: Simple Strategy to Hedge Against Rising Gasoline Prices.
Ready wrote:

I am taking a different approach - physical possession. I have well over 1000 gallons of diesel, for example, and when prices are low, I buy at the pump. This method allows me to minimize spikes and make sure I am buying low.

Keeping it fresh is a little difficulty, but once you have it worked out, it is OK. New tanks are not cheap, but can easily contribute less than $1/gal if you do it right. Also, when I have gas delivered to the farm, not only is it cheaper than the pump, it also has the added benefit of dropping the $.17 / gal state tax, so it is about $.25 / gallon cheaper.

To me, it's the same philosophy of holding physical or paper gold.

For what it's worth, you can typically get 275 gallon fuel oil tanks that are being removed due to upgrade of furnace for free or nearly free. A little elbow grease and a couple filters, and you have a physical storage of liquid gold. Check out craigslist.

Best,

Rog

Rog,

Is the "farm" diesel dyed red? Most off road diesel is dyed red BECAUSE the road tax isn't paid. Please becareful! IF you get stopped and your tank is "dipped" and they find red dye in your vehicle's fuel tank..... Big fines apply.

Also, those used 275 gallon #2 fuel oil tanks contained the "red dyed" fuel as well. A little dye goes a long way.

I'm not trying to be a wet blanket. I want folks to get the whole picture. As for me, my plan is to aquire "a few" of those tanks and build my "hedge fund" to the 1000 gallon mark as well. The easy way to keep the fuel fresh is to use a system where you rotate the supply through the tanks always using the oldest fuel first. 

FWIW - C.

Ready's picture
Ready
Status: Platinum Member (Offline)
Joined: Dec 30 2008
Posts: 917
Re: Simple Strategy to Hedge Against Rising Gasoline Prices.

Carl,

This thread is about gasoline, not diesel. There is no red dye for gas, and very few people use diesel in their vehicle in the US. The mention I made of diesel was for illustration purposes, and perhaps is only confusing the issue.

I personally burn a lot more diesel than I do gas (but I make it myself for the most part) but the same techniques apply for gasoline. So, you are not being a wet blanket, but there aren't any gasoline cops out there checking tanks, so I wanted to set the record straight on that point.

Best,

Rog

EndGamePlayer's picture
EndGamePlayer
Status: Platinum Member (Offline)
Joined: Sep 2 2008
Posts: 546
Re: Simple Strategy to Hedge Against Rising Gasoline Prices.

Wouldn't you get the same savings from Dollar-Cost-Averaging (I understand that's how UPS buys).

Example: You know you need X gallons and have calculated that into your budget. So every week you buy X + 1/8X, storing the 1/8X. When prices go up - dip into your stored only when you've spent your X-$ amount of fuel. Re-calculate the budget as needed and raise prices accordingly.

Basically, you spend the same dollar amount every week but if gas $ goes down - you've bought more and stored it. If gas $ goes up - you use reserves.

That said, at some point in time, you're going to need to adjust the budget but have some "play room".

EGP

JAG's picture
JAG
Status: Diamond Member (Offline)
Joined: Oct 26 2008
Posts: 2492
Re: Simple Strategy to Hedge Against Rising Gasoline Prices.

 I understand the desire for holding a physical commodity rather than a paper asset, but Gasoline can not be stored safely or effectively in bulk without considerable expense. I live in Houston and every year as a preparation for Hurricane season I store about 60 gallons of gas for the generator and for the truck if we have to evacuate and there is no gas available (like during the mass evacuation in Hurricane Rita). Even with using 2x the recommended amount of gas preservative, the gasoline is only viable for about a year. I'm pretty nervous about storing 60 gallons of explosive near my house, so storing any significant amount of gasoline would be extremely dangerous.(Diesel, however, is much safer to store in bulk)

Thanks for the input everyone, but the strategy that I described above is the only practical solution that I see.

npwebb's picture
npwebb
Status: Silver Member (Offline)
Joined: Mar 25 2009
Posts: 111
Re: Simple Strategy to Hedge Against Rising Gasoline Prices.

Jag,

I like what you are doing and had I read this several months ago I'd jump on board (because physical storage isn't an option for me).

However there is a question about what the SEC is going to do with Commodity based ETF's.

I've recently pulled out of all such ETF's until the dust settles.

Take a look:

http://www.moneyandmarkets.com/commodity-etfs-under-fire-from-washington-3-35395

 

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