Hedging your Bets

By Keith Heyde

Hedging is a tricky thing.

In the world of business, savvy CEO’s may hedge profits to account for slow years in the future. In some cases, this works well. For instance, within the book Valuation by Koler et al., there is a wonderfully presented example of when hedging works and when it does not. In the first scenario, the beverage manufacturer Heineken was discussed. Heineken is a company that is forced to deal with a couple of volatilities. However the dominant and never ceasing x-factor in Heineken’s bottom line is its variable rate of currency exchange.

This plays a huge role in the firm’s profit margins. Why? Well it is because of Heineken’s unique position as being a foreign manufacturer that serves predominantly the US market. Due to this fact, all of Heineken’s costs are in euro’s. That is easy enough to understand. But, the catch is that most of its revenue is in USDs. As such, there is a variable currency exchange rate inherent in Heineken’s income statements. As such, it makes sense to hedge some of the profits during beefy years so that Heineken can ride the waves on the bad years when they arise.

On the other hand, a company that has no real variability beyond their market receptivity will have a much harder times justifying hedging. For example, Dell’s costs and revenue are predominantly in USD. Therefore, if Dell were to hedge its profits, it would only be delaying a payout. This could result in unnecessary shareholder concerns and headaches, rather than the finance stability desired.

In the world of energy, there is a lot of debate around hedging.

The first issue with energy hedging is, of course, the constraints of energy storage. As of now, the only economical methods for energy storing are gravitational hydroelectric or simply fisher-troph hydrocarbons. The first requires massive infrastructure and is constrained to grid-linked applications, whereas the second has large emissions associated and a whole smattering of political issues.  

However, there are many versions of energy hedging beyond simply the energy storage market.

In fact, ‘energy hedging’ at a fundamental level has been taking place for quite some time.

Indeed, the U.S. government has long stockpiled oil in what is known as the ‘strategic reserves’. These trillions of barrels are to be released in times of either tight economic constraints in the oil market, or for crucial survival situations.

But, what is really the point of the strategic reserves?

When there is chatter of high oil prices around election season, sometimes the strategic reserves are accessed for less than strategic reasons. Rather than for oil constraints, it seems as if strategic reserves are tapped into for economic considerations.

But, no matter how high the price of gas is at the pump, it shouldn’t justify the release of the strategic reserves for political agendas.

It is time that our politicians and energy policy crafters thought a bit further in the future than simply the next election cycle. The endless banter around energy policies that offer only near term solutions needs to stop, otherwise we are doomed to extinguish all the easiest (and least sustainable) sources, before we can establish a versatile and adaptable infrastructure.

Perhaps all energy decisions should be privatized, because at least corporations need to worry about their longevity based upon their performance.

It’s time for the DOE to stop hedging their bets and tackle energy head on. No more wading in the pond, lets dive in.

And, for all of your energy news and thoughts check back in to www.energygridiq.com today.