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Managing Fuel Prices

Posted Feb. 1, 2009

Three major inputs have a direct impact on the bottom line of an agricultural operation: feed, fertilizer and fuel. All three of these inputs experienced a decrease in price in late 2008 and early 2009, but the drastic decrease in the price of fuel will be the focus of this article. We'll also look at how agricultural producers can take advantage of today's fuel market for their individual needs.

On July 11, 2008, crude oil was at an all time high of $147.27 per barrel. As of Dec. 22, 2008, crude oil was $39.91 per barrel - a decline of $107 or 73 percent from the July record. According to the Energy Information Administration's energy outlook as of December 2008, the government's price forecast for gasoline and diesel fuel for 2009 was $2.03 and $2.47 per gallon respectively.1 The following graph shows yearly diesel fuel prices for 2006 through 2008.

If you believe fuel prices are going to rise in the coming year, there are two main strategies that will allow you to take advantage of current fuel prices for future agricultural production. These two strategies are to purchase fuel and have it delivered to an on-farm storage facility or to acquire shares of Powershares Deutsche Bank Oil exchange-traded fund.

The first option allows producers to purchase several months of fuel supplies to take advantage of current lows in the market. In addition, this option allows convenient filling of fuel tanks without making trips to town. Normally, several options exist when deciding where to purchase fuel for storage on the farm.

The second option was developed by an agricultural economist at Kansas State University to take advantage of seasonality patterns in diesel fuel and rising fuel prices. Dr. Kevin Dhuyvetter analyzed the Deutsche Bank crude oil exchange-traded fund and found that by purchasing one share of the fund, you could effectively hedge 11 to 12 gallons of diesel. The description of the Deutsche Bank crude oil fund says that the fund is a "rules-based index composed of futures contracts on Light Sweet Crude Oil and is intended to reflect the performance of crude oil."2 If someone is interested in using this fund to hedge their fuel, they must contact a financial institution that has the ability to access the New York Stock Exchange. It is important to note that this trading is different than trading commodities and most likely will require a different broker.

There are at least two risks when using the second option to hedge fuel costs. The first risk is "basis risk," or the difference between the cash price of fuel versus the futures price of crude oil. Basis can fluctuate throughout the year, and these values could vary between a positive and a negative basis. The second risk would be if the Deutsche Bank fund would begin to diverge from the performance of crude oil in the commodity market, but, as the description states, the fund is based on the performance of crude oil in the futures market.

Agricultural producers have experienced extreme decreases in the prices of commodities during the past several months. In times of falling prices, there are options available to minimize costs to benefit the bottom line of an operation. For more information on using these tools for reducing fuel price risk, please contact me or another Noble Research Institute agricultural economic consultant at (580) 223-5810.

1 http://www.eia.doe.gov/steo
2 http://dbfunds.db.com/dbo/index.aspx