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Aiden Owens

Grade: 11

University High School

Instructor: Kevin O'Brien

How to Lock in Gas Prices: Hedging with Shares of UGA

Journalism

How to Lock in Gas Prices: Hedging with Shares of UGA

What if the everyday investor had the opportunity to secure their gas price for the full year for just as little as $300? So instead of making the sad walk from the car to the pump, investors can rest assured that they won't have to deal with the volatility of gas prices.

Gas prices are steadily increasing across the country from a low of $1.90 a gallon in April 2020 to a price of $3.40 per gallon in November 2021. In just a year and a half, gasoline prices increased 179%. According to energy.gov, the average American uses about 474 gallons of gasoline per year. With a $1.90 gas price, Americans would theoretically spend around $900.60. But with prices where they are as of late 2021, the average American is looking at spending $1,611 per year, or an extra $710.4. Rising prices are due to a multitude of factors including growing amounts of travel, rising crude oil prices, and declining output from US-based refineries. The most valuable physical resource is raising prices but instead of talking about geopolitical relations in the Middle East, a much more effective route is to learn how to lock-in or "hedge" gasoline prices so you don't have to deal with the volatility of fuel prices.

Hedging is a risk management tactic that is used by some of the largest investors in the world to help offset investment losses by taking opposite positions in related assets. Hedging is commonly found in retirement portfolios in which an investor will hold a combination of stocks and bonds. The investor hopes that a stock price drop or loss will be offset by bonds. Large companies use hedging in order to purchase everything from precious metals to agricultural goods. Even refiners use this strategy to ensure their profit margins remain fixed by buying crude oil and selling refined products. But instead of hedging against a downturn in stocks, how can investors hedge against gas prices?

In order to hedge against gasoline prices, investers need another initial product that tracks the price of gasoline that is easily accessible through a brokerage account. Thankfully, USCF Investments has issued products like the United States Gasoline Fund or ticker "UGA" in the form of an exchange traded fund (ETF). The funds' goal is to attempt to match the average price of gasoline across America. They achieve this by holding reformulated blendstock for oxygenate blending futures, or more commonly called gasoline RBOB futures. Instead of taking on $90,000 of leverage in one gasoline RBOB futures contract, UGA gives exposure to the underlying RBOB future for only around $40 per share.

As of November 2021, UGA is trading around $40 per share and the price of gasoline in America is on average $3.40 per gallon according to AAA Gas Prices. Meaning that at this point in time if you buy one share of UGA at $40 one would control around 11.7 gallons of gasoline, this is known as a Hedging Multiple. Due to the fact that the $40 that UGA costs goes into $3.40, the price of gas is around 11.7 times. With this value, we can now calculate the amount we would require in order to fully hedge our yearly gas spending. It is important to understand how much gasoline you actively use on a yearly basis for the hedge to be executed correctly. If we then take the number of total required gas and divide it by our hedging multiple of around 11.7 gallons, we find the average American should purchese around 41 shares of UGA.

  • Current UGA Price / Average Gasoline Price = Hedging Multiple
  • Total Yearly Consumed Gas / Hedging multiple = Number of Required Shares

If investors were to go out of their way to apply a very complex strategy, then one would expect to be fully protected from all gas fluctuation and volatility in the future. For example, gas prices rise from $3.40 to $3.70. With your average gas consumption of 474 gallons per year, that's an increase of $142.2 dollars in a yearly budget. But with a hedge against gas, your share price would theoretically rise from $40.00 to $43.6 netting a total profit of $147.60 on your 41 shares of UGA. While the figures aren't exactly equal, it is certainly better than not doing anything and funding the extra $142.20.

One large downside to the strategy is that you must have around $3000 liquid in order to purchase shares of UGA depending on where the price moves. One way for investors to lower their required capital is to use a leveraged instrument. Stock Options are a great way to get exposure to the underlying UGA stock by only putting up sometimes as little as 10% of the original capital. While this does involve taking on more risks like assignment risk. Since investors purchase stock options, that means they are indirectly controlling 100 shares of UGA. The one issue with the stock options route is that investors will need to close renew their options contracts every few months. While not as smooth as the shares route, stock options grant investors leverage, and as a result lower capital requirements.

The best time to execute this strategy is when gas prices are low relative to the last few months to a few years. Back in 2020 when gas was lower than $2.00, if used correctly the hedge would protect investors against the rising price and they would still be paying less than $2.00 a gallon even today!