Every business can benefit from hedging, either directly or indirectly. Hedging gasoline improves pump prices. Since every industry depends on transportation of products or merchandise hedging gasoline prices can reduce net cost of goods sold. If consumers spend less on necessities, this increases their disposable dollars thereby providing additional dollars for investments or supplying wants.
For example, let’s discuss bananas. The consumer cost of bananas at the check out line is $0.54 per pound, which is about 2 bananas. Included in the cost of bananas are the growing and harvesting costs of the farmer in South America; the transportation by truck from the farm to the buyer; costs from the country of origin by ships, trucks and/or trains; import tariffs; and transportation to the warehouse then on to your grocery store. Each of the vehicles in this process requires energy, primarily gasoline and oil.
Hedging allows the retailer to reduce net cost of transportation from the warehouse; the distributor to reduce net cost from country of origin; and the farmer can reduce cost of growing and harvesting the two bananas. Each step in the process is reducing their cost, and in order to increase their market share, they pass that savings along the chain to the end consumer.
This brief composition will illustrate how consumers’ gasoline prices can be reduced while corporate retailers continue to profit by neutralizing the fluctuations and increasing pump sales. It will illustrate hedging techniques to reduce transportation costs & increase profit in increasing gas prices; recession proof your business.
Hedging is the technique of capturing price movements in financial markets to offset price increases or price reductions dependent on the desired market direction. Hedgers are not speculators; they are not seeking profits in their markets. They are seeking to neutralize the price fluctuations inherent in the oil and gasoline industry.
Hedging, as illustrated here, is the buying and selling of oil and gas futures contracts. A futures contract is an agreement to buy or sell the product at a designated time in the future. Gasoline hedgers buy and sell specific numbers of futures contracts according to the amount of gasoline bought and sold by the corporate client. For example; if a corporation maintains a supply of 100,000 gallons of gasoline and the current cost of the gasoline is $3.00 per gallon, its total cost is $300,000. The gasoline is sold to consumers for $4.00 per gallon. At a retail cost of $4.00 per gallon the corporation will sell 75,000 gallons of gas in 1 week. The weekly sales will be $300,000; a gross profit of $75,000.
If the wholesale price of gas increases $0.50 per gallon and the pump price is adjusted equitably, the retail price of the gasoline is $4.50. The supply and demand theory, as well as the past sales history of the retailer confirms that the corporation will sell only 65,625 gallons at this increased price and will receive a gross profit of $65,625 a relative loss of $9,375.
However, if the corporate retailer is hedging, it can maintain retail prices with a net cost of $3.00. The supply and demand theory illustrates that if the corporate retailer maintains its pump prices at $4.00 while its competition raises its prices $0.50 per gallon the hedging corporate retailer will increase the number of gallons sold by approximately 12.5%. The corporation will now sell 84,375 gallons per week maintaining a gross profit of $1.00 per gallon or $84,375; an increase in relative profits of $ 9,375.
Standard
Cost $3.00/gal
Retail $4.00/gal
Sold 75,000 gallons
Cost $ 225,000
Retail $ 300,000
Profit $ 75,000
Price increase of $0.50
Cost $3.50/gal
Retail $4.50/gal
Sold 65,625 gallons
Cost $ 229,687
Retail $ 295,312
Loss $ 9,375*
Price increase with hedging
Net Cost $3.00/gal
Retail $4.00/gal
Sold 84,375 gallons
Cost $ 253,125
Retail $ 337,500
Profit $ 9,375**
*Relative loss from decreased sales
**Relative profit from increased sales
This in mind, there is seldom a direct relationship between supply and demand with utilitarian products such as gasoline. It is typically the case that lower prices of gasoline create a higher than standard increase in pump sales thereby higher profits. If corporate retailers would hedge gasoline price fluctuations then lower pump prices would bring increased sales and profits.
The same holds true in declining market conditions. Hedging allows the corporate retailer to secure profits in declining gas prices; however, maximum benefit occurs with the opportunity of beating the competitions’ pump prices.
Transportation
2007 though 2008 saw a dramatic increase in grocery prices. This trend continues, while consumers were not benefiting from gas price reductions, consumer prices at the check out did not drop equally to the cost of gasoline. Yet consumer prices continue to rise as gasoline again increases over $4.00 per gallon. By utilizing the hedging techniques illustrated above, retailers will be able to roll back prices on many staple grocery items; provide consumers with increased discretionary spending on general merchandise; increase capital for expansion projects; increase labor force; increase profits. All equates to happier consumers.
Don’t let the cycle continue. Recharge the economy. Recession proof your business.
Readers can contact the author at: chardingsmith@goldenglobe.us
Comments