Companies purchasing electricity derivatives should ensure that advice is provided by an intermediary with experience in this relatively new market, somewhat different from other energy derivatives markets and very different from interest rate and commodity derivatives. Portfolio managers, individual investors and companies use hedging techniques to reduce their risk relative to different risks. However, in financial markets, coverage is not as simple as paying an annual insurance tax for an insurance company. Suppose six months pass and the farmer is willing to harvest and sell his wheat at the prevailing market price. Indeed, the market price fell to only $32 a bushel. He sells his wheat for that price. At the same time, he redeemed his short-term contract at $32, generating a net profit of $8. So he sells his wheat for $32 plus $8 hedging profit – $40. He basically blocked the $40 price when he planted his crop. The company uses NYMEX Futures and over-the-counter swaps, collars and options.
„We don`t have a specific rule on the amount of hedging to use,” says one dow hedge strategist, although the company almost always has a long time to oppose a rise in gas prices – it doesn`t worry about a possible price drop. A hedging strategy generally refers to the general risk management policy of a company acting financially and physically, on how to minimize its risks. As the term „hedging” indicates, this risk reduction is generally achieved through the use of financial instruments, but a hedging strategy, as used by commodity traders and large energy companies, generally refers to an economic model (including financial and physical transactions). However, a larger company exposed to greater risks can often benefit from a derivatives trading program. United Parcel Service, the distribution company, has been living up its energy risk for a decade. In 1998, fuel accounted for 2.8% of the airline`s operating expenses. The company has a large fleet of jets as well as known brown trucks that consume large amounts of diesel, jet fuel and gasoline. For hedging, UPS uses futures, futures and options that work both on and off the stock market.
The company has several employees who are dedicated to full-time hedging in its cash group. Bob Clanin, UPS CFO, checks for any policy changes. They look at the price of energy on a daily basis and decide which share they want to cover their overall needs.