Basis contracts offer distributors another great option for your company to diversify your petroleum purchases and pricing options. This article provides an explanation of what basis is, as well as examples and scenarios of how your company could be using basis contracts to manage your supply risk and give you an advantage against racks. Contact us to learn more – click here.
What is basis?
Let’s make sure we’re all on the same page – basis is the difference between the cash price and a benchmark price.
The basis price can fluctuate daily and is affected by transportation costs and local supply and demand. In a basis contract you are fixing the basis price with the intent of locking in the final price at a later time. In a typical forward or prompt contract you would be locking in a final price immediately for the entire contract gallons.
Example: For our purposes we will be using the New York Mercantile Exchange (NYMEX) price as a benchmark. For example if you can buy Diesel for $1.80 a gallon at your local terminal and the current NYMEX price is $1.75 your basis is $.05.
How basis contracts work might become more apparent once we address why basis contracts are used.
How to use basis contracts to manage supply risk?
Basis contracts can be used for risk management purposes to guarantee supply and protect against an increase in the basis. This provides supply and price stability that can be very valuable when there are local or regional supply shortages or demand spikes. You know your gallons will be available and priced at the current market.
Basis contracts can also give you an advantage in a volatile market.
Basis contracts allow you to diversify your rack purchases. AMERIgreen has a basis contract that allows you to price out your gallons in 7,500 gallon increments instead of the standard 42,000 gallon increments. This basis contract can be used to complement your rack purchases while also providing basis and supply protection. These contracts are priced off the current day’s settlement price plus or minus your locked in basis.
Example: Here is an example of how an AMERIgreen basis deal works.
On Monday the NYMEX ULSD settles at $1.65. Around 6 PM rack prices adjust for the following day. The lowest available rack price is $1.62, $.03 below the market settlement. On Tuesday the market is down 3 cents trading $1.62.
You have a basis contract with a locked in basis of $-.025. Since the market is down today you would buy off your basis contract instead of the rack for your daily requirements. If the market settles 3 cents down at $1.62 you pay $1.595 for your fuel that day, 2.5 cents below your best rack.
Closing Thoughts & Information
When used as a part of your overall purchasing strategy basis contracts provide additional pricing options as well as basis risk protection.
For pricing or more information on how basis contracts work please give me call Vinson: (717) 947-7000 or send him an email: firstname.lastname@example.org. I would love to talk about this in more detail.