How can I hedge against rising diesel prices?

By Casey Murphy AAA
A:

In early 2007, the New York Mercantile Exchange announced that traders would be able to buy or sell futures contracts on New York Harbor ultra low sulfur diesel and U.S Gulf Coast ultra low sulfur diesel. These contracts can be used by traders to hedge against rising or falling diesel prices. The contracts started trading on the New York Mercantile Exchange on May 13, 2007. (For background reading, see A Beginner's Guide To Hedging.)

Another interesting point about learning to hedge against rising diesel prices is to understand the process by which this product is made and how it is priced in the commercial market.

One common method used to answering this question lies in learning about a petroleum product known as heating oil. This product is also known as No.2 fuel and is used primarily to heat homes and buildings by fueling furnaces/boilers. When hedging diesel prices, heating oil is important because the two fuels are produced together and are chemically similar. Diesel fuel is often priced at a stable premium to the price of heating oil, which is an underlying commodity of futures contracts listed on the New York Mercantile Exchange.

If you plan to purchase a significant amount of diesel at a later date and you also believe that the price of diesel is going to increase, you may want to take a long position in heating oil futures. This long position will enable you to profit if the price of heating oil does continue to rise prior to the date you wish to purchase the diesel.

(To learn more about futures, see our Futures Fundamentals tutorial.)

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