How To Hedge Against Rising Gas and Oil Prices?

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Everybody’s talking about gas prices… they’ve reached another high, everybody wants a hybrid… so why not explore how an individual can try to limit their exposure to gas prices?

How much more are you really paying?
Yes, $50 for a fill-up hits some sort of mental trigger, but sometimes I wonder if people really have calculated exactly how much more they are paying. According to AAA, the current national average is $3.70/gal, while a year ago it was $3.05. If your car gets 20 miles per gallon, you drive 12,000 miles per year, paying 65 cents more per gallon equates to an extra $390 per year. (If you got a stimulus check, this means a lot of it might have already been spent…)

Now, for many families who are walking a financial tightrope, such a hard-to-avoid increase is just a another step closer to the edge. But for the Wii-playing, Starbucks-drinking crowd, is an extra $32/month really worth making a fuss over? I mean, some of these folks are the same ones whose eyes glaze over when I describe some of the extra things I do for money outside of a regular workday.

Hedging Against Future Increases
Now, someone could always play with oil futures contracts like the airlines do, but that’s a bit complicated for the average person. However, if we are afraid that gas prices will rise even further but are comfortable paying the current price, it would make sense to try and buy a bunch of gas at today’s prices and lock-in that rate. A while ago there was a company called the FuelBank that tried to make this a reality, but it appears to have gone nowhere.

Buying the Oil ETF USO
Another way that you can effectively buy at today’s prices is to buy shares of the United States Oil ETF, symbol USO, from your favorite online stock broker. This idea was initially explored in this SeekingAlpha article back when it debuted in 2006. Unlike other commodities ETFs or investing in an energy company like Chevron or Exxon, the objective of this ETF is specifically to keep it’s net asset value (NAV) at the price of crude oil. (Specifically, the spot price of West Texas Intermediate light, sweet crude oil delivered to Cushing, Okla., minus expenses.)

Now, USO hasn’t done the best job of tracking crude oil prices exactly on a day-to-day basis, but it seems to get the general trend right if you hold an extended period of time. From 5/7/07 to 5/6/08, crude oil went from $61.48 to $121.82 a barrel, an increase of 98%. (source) For the same date range, USO went from $48.06 to $93.38 a share, up 94%. (source)

In order to counteract the theoretical $390 from the example above back, you could have bought 9 shares of USO for a total upfront cost of $390 a year ago, which would be worth $408 more today. So in theory, the average driver could put aside something like $1,000 and buy 10 shares of USO to hedge against rising gas prices. Even just one share would dampen the effects somewhat.

The Catches
Unleaded gas prices only went up 21% in the same time period that crude oil went up nearly 100%. So the ratio between crude oil price and unleaded gasoline doesn’t seem to be a constant. Also, if gas prices fall then your savings at the pump will likely also be negated by a drop in USO’s share price. Also, you could account for the lost potential of any money put aside for this if you had invested it elsewhere.

I don’t personally plan on doing this, but it is an idea that could work if you were really sensitive to higher gas prices and/or buy a lot of gas. Another alternative is a site like HedgeStreet, though I haven’t looked too deeply into it.

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Comments

  1. Is there any evidence that people are really changing the way they live in response to gas prices? It seems to be something we complain about, but as individuals, what are people actually doing? Does it now make economic sense to trade in your SUV, or do you just drive it a little less and buy a smaller car next time? Is it really cheaper or more practical to take mass transit now, and if not now, when does the tipping point come?

  2. I would like to point out that the real cost of oil is not just from gas prices at the pump, but the cost it has on the whole economy. Anything that requires transport such as milk, clothes, tools etc. becomes more expensive as it has to be trucked or shipped in. Manufacturing goods also increase from the higher energy cost.

  3. One way to hedge against the “crack spread” (i.e. the amount that gasoline rises in cost that is not accounted for in the price of oil) is to invest in refineries, like FTO. They make higher profits when there is a higher crack spread.

    I have no intention of doing anything like this myself.

  4. I think you’re missing the point of increasing gas prices. Sure, it’s only $32 a month more for gas for your car if you drive 12,000 miles, but what you need to focus on is the effect that this increase will have on everything else. Airlines have already increased their prices $20 per flight, the postage stamp will be raising in price again tomorrow. Have you looked at UPS and FedEx’s shipment increases? I can’t seem to find anything to be shipped for less than $10 at Newegg when everything used to be $5.

    This kind of effect will be reproduced on everything you buy. Grocery stores are already increasing prices on products because getting it to their inventory costs so much. Sure 65 cents here and there isn’t that big of a deal for your car, but the gas price increase effects every single service and product in the United States.

    That’s the REAL problem.

  5. Actually, food has been increasing in price independent of oil. In fact oil price increases this year are just part of a general trend of higher commodity prices, not anything special. They haven’t even increased the most–instead they are roughly in the middle.

    So let’s not assume oil is all that matters. Basic economic principles still work. So when the Fed drops to negative real rates, of course commodities will shoot up. It’s just as you’d expect.

  6. we have an economy built on oil, communities built around the car, and a society that likes plastic and “its disposable” items. we are lying in the bed we have made.

  7. How come all the bloggers that talk about USO are clueless???

    USO is not a typical ETF, just like all other commodities ETFs. That is set up as a partnership that trades future contracts. It’s marked to market, and even if you don’t sell, you pay 40% short-term capital gain.

    Also, a lot of buyers from last year regretted about buying it because a lot of them ended up paying much more tax on a number that’s much more their realized gain. Furthermore, USO is not for retailer invstors because of its complex K-1 tax form.

    The best ETF for oil is still XLE, not USO.

  8. XLE may have a better tax structure, but I don’t think they are necessarily comparable ETFs since XLE invests in an index of energy companies (20% Exxon), not the actual price of the commodity. The correlations seems to be relatively low.

    Performance of XLE
    Trailing YTD: 7.11%
    Trailing 1-Year: 32.23%

    Performance of USO
    Trailing YTD: 34.79%
    Trailing 1-Year: 112.71%

    I wish I could simply graph the correlation between retail gas prices and either of these ETFs to see which is a better hedge, but I haven’t found an easy data source and I just don’t care enough to manually put it together 🙂

  9. XLE is not a better hedge but it’s not a TAXING NIGHTMARE like USO.

    Google “uso k-1 tax”.

  10. The entire discussion thread on USO tax implications: link

  11. Jonathan, you’re absolutely right about this. The very same people that complain about the gas prices are the ones that said that your strategy for picking up free carts at airport concourses while waiting for your baggage wasn’t worth the effort. I hope you continue posting about things like Pinecone Surveys and Credit Card promotions, because I enjoy reading them and can incorporate them into my life as well.

  12. What are the tax nightmares that are caused by USO if anyone puts them in a after tax account?

  13. After a brief review, it would appear that most of that Yahoo Finance thread discussion about tax issues are people yelling that didn’t read the instructions. Any K-1 income that was not actually received just adds to your basis. In particular, read posts by user lisahuang54321, including this one: link

  14. Currently my retirement account asset allocation is overweight in energy and gold so I’ll be able to retire someday if even if energy prices and inflation continue at these high levels.

    It doesn’t seem practical for individual consumers to hedge against rising gas prices (I do recall Southwest Airlines making out like a bandit a few years back because they hedged against rising jet fuel prices).

    OTHO you might be able to lock in a good long term rate with your electricity provider. I guess that might be state dependant. In TX you can swap electricity providers like long distance carriers.

  15. Every few months someone calls up on the Suze Orman show and wants to buy a $26k hybrid because they’re “Spending too much on gas.” Suze puts them in their place by explaining to them that paying $500/month for a new car makes no sense in order to save $80/month in the short term.

    Me? My response to higher gas prices is to get more mileage FOR FREE by HYPERMILING my “normal” non-hybrid car:

    http://www.cleanmpg.com/forums/showthread.php?t=1510

  16. what is the best place to find if a fund will send a 1099 or k-1? Prospectus is too big and I searched for “1099” or “k-1” but could not find it.
    For. eg. I was think about TIP fund for bonds…
    Thanks

  17. So how come you’re not planning on doing this? 🙂 I’m curious. I’ve been considering it myself and I think perhaps the S&P 500 would ultimately provide a better return, but oil prices will probably continue to rise steadily in the long term…

  18. Paul J Barrella says

    Gas Prices has gone up because of bush he’s been spending too much of our money!! so the only way to pay it back is through us! The world bank & the IMF these are banks that fund other countries & when it goes sour we have to pay it back through oil & gas prices the answer is to impeach bush & stop the war & worry about our country ,look at us now we have to worry about keeping our houses & to put food on our tables,ya think the government cares about us,we should stop paying them to do this to us & keep imigrants out,funny when we need help we are rejected they come into this country they get everything we work for ,we just might as well walk up to one & give our money out of our wallets, our country we should take back & riot this the only way to keep our freedom!!!! Oh hold on you think the gas prices are bad now, we are going to $7.00 a gallon thats the prediction riot,riot,riot if we dont we get no where!!!!

  19. Paul J Barrella says

    forgot to say we have oil in our own counrty(alaska) enough to supply the united states for 200 yrs, government has been lying to all,fact

  20. They now have http://www.mygallons.com where you can buy prepay for gas as set prices. What do you think?

  21. Spence Brown says

    MyGallons got shut down by the Better Business Bureau. Fortunately I got my money back when I complained to my credit card company.

  22. NaturalGasDrillsOilMan says

    I do believe the rise of gas prices has changed people’s behaviors more than in the past………..and now with Starbuck’s closing what are those same people, you mentioned in your article, going to do?

    What do you think of CNG?

  23. Here we are in April 2009, no one has been talking or fretting much about gas prices since they feel to under $2.00 a gallon, I think we saw $1.60 here in Oregon before it began a steady rise back up and over the $2.00 mark once again. I don’t keep up with the stock market, and I understand little of how it works, what I have read but don’t understand is how APEC reacted in December08 – January 09 to reduce it’s crude production in order to drive demand thus driving prices. From strictly the consumer’s standpoint and not a stock holders, I don’t understand this. I do understand that they would like to keep making more money on the comodity, just as I would love to be able to double my salary at work. Maybe if I made myself more scarce to my boss he would double my pay because now I’m in higher demand, but that won’t work will it, because they can replace me, while I cannot replace my need for gasoline. I can’t afford a new more fuel efficent car, and I live in a smaller city with no public transportation and no one to car pool with. There are millions in that same position. You would think the oil execs would get the concept of why the demand fell in the first place, people simply cannot afford to pay for it at 4.85 a gallon. We stopped going anywhere that wasn’t from home to work and back, and the grocery store had to be on the way, because every mile counts at that price. That’s obviously what everyone elce was doing, so the demand dropped along with the stock right? So in order to keep lining their pockets, since they know we can’t just go somewhere else for our oil, and we can’t just stop driving, and the majority of us can’t just go by a hybrid tomorrow, and those who can are still buying far less gas, it all equals less demand. Am I the only one thinking that this is wrong? I think it comes down to the fact that oil is a dirty industry full of greed, and the facts are simple, we can’t go anywhere else to get it, and the alternatives of electric cars and cars that run on alternative fuels has been suppressed by those with stock in the oil industry, and I think we all know who I’m talking about. Watch ” Who killed the electric car” that will get you thinking. Anyone else care to comment?

  24. CORRECTION TO ABOVE COMMENT: PLEASE NOTE WHERE I STATED “APEC” WAS AN ERROR, I MEANT OPEC, BUT CANNOT FIND A WAY TO EDIT ONCE SUBMITTED SORRY FOR ANY CONFUSION

  25. Great Article. Thanks for the info. Does anyone know where I can find a blank “2014 IRS 1041 – Schedule K-1” to fill out?

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