FUTURES HEDGERS PLAYING HARDBALL

FUTURES HEDGERS PLAYING HARDBALL

Participation in the New York Mercantile Exchange's heating oil futures contract continues to grow as market players try to gain some advantage in an increasingly competitive atmosphere.

Wholesale marketers - many of them large retailers in their own right - are the sector most under the gun to respond to price pressure, and they have accounted for a large portion of the growth in the past year.Their presence, either through their own hedging activities or through risk managers, is expected to increase as they seek price protection and better control over margins.

Retail heating oil dealers, historically reluctant to become direct participants in the Nymex, largely remain indirect players through their wholesalers, either buying wet gallons in straight forward Nymex deals or through various fixed or capped price programs linked to more complex hedging strategies.

However, an increasing number of retailers have decided to augment those programs by trading the contract directly and using the hedging strategies it allows.

For its part, the Nymex is making a concerted effort to attract participation from the midwestern states, and exchange officials believe growth from that sector will be significant.

By all accounts, 1991 was a good year for the Nymex heating oil futures contract. On Aug. 19, an all-time volume record was set when 321,845 contracts were traded. Open interest, an indicator of hedging activity, increased 55 percent over the two-year period ended Sept. 13, and the 113,559 open contracts in December represented a 57 percent increase over the year before.

"We saw tremendous growth in participation. It was 40 percent to 45 percent higher than in 1990. A great deal of that growth came from the wholesaler level," said R. Patrick Thompson, president of the Nymex.

A survey reported by the Energy Information Administration found that 83 percent of the retail heating oil dealers in the Northeast and 56 percent in the mid-Atlantic region offered guaranteed prices this winter, an oblique testimony to the increase in wholesaler hedging activities.

"Wholesalers are doing a lot more volume and offering a wide variety of marketing programs to retail dealers and large end-users like fixed prices, capped prices, and floating prices," said Robert Boslego, president of The Boslego Corp., a Winchester, Mass., consulting firm that advises petroleum companies about hedging and profit-making on the Nymex.

Global Petroleum Corp. of Waltham, Mass., for example, offers its customers a "price assurance control" contract, which fixes the price per gallon in the winter months at 3 cents or so higher than the Nymex price, but offers downside protection, explained Joseph De Stefano, marketing vice president at Global.

The company does all its own hedging, but until recently, like many other wholesalers, it has been laying off the risk of its pricing programs with professional risk managers.

Mt. Lucas Associates of Princeton, N.J., had been providing the guaranteed program swap for Global for about three years, said Alan Kaufman, president of Mt. Lucas. He said Global is big enough and familiar enough with the market to be doing it on its own.

Mt. Lucas' clients include producers, some refiners, large end-users and wholesalers, Mr. Kaufman said. The company will devise risk management programs for clients, act as market makers for swaps, or manage all the risk through their own accounts, he said.

The wholesale sector will continue to account for a major part of the volume growth in futures trading, because they are under the most competitive price

pressure, said Mr. Kaufman.

Mr. Boslego agrees: "There will be more and more activity from the bigger players like foreign oil interests, major oil companies, and especially the larger wholesalers as they offer more pricing options to their customers."

Historically, retail dealers have stayed away from the Nymex because they felt they have no place in a market dominated by "the big boys."

That view still predominates, and Mr. Boslego believes it is valid. He feels most retail dealers should not be direct participants, having neither the volume nor the number of personnel to justify the commitment to the market.

He says a typical dealer, one who sells between 10 million and 15 million gallons a year is too small, and the market may be iffy even for dealers who sell 50 million to 75 million gallons annually.

Moreover, as wholesalers continue to offer pricing programs, they alleviate the need for retailers to interact directly with the Nymex, he said.

However, Alan Levine, a broker and vice president at Shearson Lehman Brothers in Bethesda, Md., thinks that view is wrong and says, "with intelligent management and a judicious use of futures and options," there is a place for any size company in the market.

He says he is hedging for a substantial number of new clients, many of them retail oil dealers. "That class of trade has expanded by multiples," he said.

Douglas Woosnam, president of Sinkler Inc., a 12-million-gallon-a-year oil dealership in Southhampton, Pa., has been directly involved with the market for a number of years. He also participates in price protection programs with his supplier.

"I don't think you can say the Merc is good for the big companies and bad for the small ones. It is unfortunate that a lot of smaller dealers don't understand how it works, but it gives you the tools and the ability to limit risk," he said.

Mr. Woosnam, is chairman of the Petroleum Marketers Association of America's heating fuels committee.

It is one more way "to eliminate the crapshoot," said Bob Irvin, president of the Mid-Atlantic Petroleum Distributors Association.

Vera Haskins, vice president of Mauger and Co. of Frazer, Pa., trades through Mr. Levine. She thinks retail dealers that decide to use the market must make the commitment to be involved day-to-day.

Mr. Thompson agrees: "We certainly believe the contract is open to all. They need to make the internal commitment and judge the expense relative to their size."

Retailers, especially, have been under the impression that speculators control and manipulate the market. In fact, speculators have played a small - albeit necessary - role over the years, according to market participants.

Statistics kept by the market surveilance unit of the Commodities Futures Trading Commission characterize open interest of reportable trades according to whether they are commercial positions, and therefore hedges, or non- commercial positions and therefore speculative. For the heating oil contract, positions of 150 or more contracts must be reported.

Of the reportable positions on Dec. 31, 53.9 percent of the long, or buy, positions were hedges, while 7.5 percent were speculative. Of the short, or sell, positions, 53.2 percent were hedges, while 9.4 percent were speculative.

Of course, if retailers were looking for reasons not to be involved at all in the market, either directly or indirectly, this season has given them plenty of ammunition.

"Who could have known that June heating oil would be selling at a premium to January oil in December," asked Mr. Woosnam.

One dealer in New Hampshire has said he will have to sell oil below the fixed price that his customers contracted for, in order to meet current prices offered by discount dealers.

A common notion among many retailers this season is that, if they had stuck their heads in the sand and done nothing except buy oil as needed, they would have done as well or better than if they had used hedging techniques.

Proponents of the market say that one must be ever-mindful of the long haul. Over time, in the long-term, hedging strategies allow for better control over

margins and the increased ability to survive, said Mr. Kaufman.

One group that may never join the Nymex is the oil community in the Pacific Northwest. The basis risk between the New York harbor price and prices out west is just too high, said Mr. Boslego.

However, the Nymex thinks they have alleviated some of the concerns about basis risk that had been expressed by midwestern heating oil wholesalers. And Mr. Thompson expects them to begin participating in the futures contract next season.