Guidebook for Evaluating Fuel Purchasing Strategies for Public Transit Agencies (2012)

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23 Hedging with Cap-Price Instruments Cap-price instruments create a price ceiling that prevents fuel prices from exceeding a certain level. They are often compared to insurance: the buyer pays a premium in exchange for protection against a bad outcome. As with forward-price instruments, the buyer of the cap instrument is credited the difference when fuel prices exceed the price specified in the contract (called the strike price). Unlike forward contracts, however, the buyer does not pay out money when prices fall. When purchasing physical fuel, gains from fuel price declines are not offset by losses on the cap-price instrument. This type of win-win protection is not free. Unlike forward contracts, which are essentially costless (other than brokerage fees) at initiation, cap-price instruments require the buyer to pay a premium to the seller. This payment is not collateral; it is an actual outflow of money from the buyer to the seller to compensate the seller for undertaking the risk of selling cap-price protection. Premiums on cap-price instruments are determined by a number of factors including the spot price of fuel at initiation, the price specified in the price cap (the strike price), the maturity of the instrument, interest rates, and the volatility of the fuel market at the time the contract is initiated. Typically, the strike price of the cap-price instruments is set out-of-the-money, which means that fuel prices would need to rise significantly before the cap would pay out for the buyer. The higher that the strike price is relative to the spot price at initiation, the lower the cost of the premium will be. Typically the premium is paid upfront at the time the instrument is purchased, but some instruments allow for deferred premium payments (although such deferred payment plans require higher overall premium payments). Historically, cap-price instruments have rarely been used by transit agencies due to the high cost of premiums. Structuring options to create participating caps, collars, and price corridors reduces or eliminates the premium on cap-price instruments. There are essentially three ways to achieve cap-price protection: 1. Purchasing OTC or exchange-traded options contracts; 2. Participating in a web-based fuel price protection program; or 3. Having a fuel supplier provide protection via a cap-price physical fuel supply contract. The pros and cons of the third method were discussed in the Section 3.3. OTC options con- tracts and web-based fuel price protection programs will be discussed in the following sections. 4.1 Options Contracts Options contracts give the buyer the right, but not obligation, to purchase or sell fuel at a specific price (the strike price) over a specified period of time. American-style options allow the buyer to exercise the option at any point before expiration while European-style options can only be exer- cised at maturity. There are two basic types of options: call options that give the right to buy fuel at a specific price, and put options that give the right to sell options at a specific price. Options contracts S e c t i o n 4

24 Guidebook for evaluating Fuel Purchasing Strategies for Public transit Agencies are further classified based on whether the option is being bought or sold. A full explanation of the different types of options available to transit agencies is beyond the scope of this overview. The strike price on an option is typically set out-of-the-money at initiation, meaning that there is no value to exercising the option because the spot price of the fuel is more advantageous than the strike price of the option. As prices change over time, however, an option can become in-the-money, meaning that the strike price is advantageous compared to the spot price and the options contract will pay out if exercised. As with forward contracts, payouts on options are typically settled on a cash basis. In other words, the seller does not actually sell physical fuel to the buyer, but pays the buyer the difference between the market price at the time the option is exercised and the strike price that was agreed at initiation. The buyer of an option has the right, but not obligation, to exercise the option. This means that if the market price is lower than the strike price, a purchased call option would be out-of-the-money and the buyer would not benefit from exercising the option. In this case, the buyer would simply let the contract expire. Fuel price options can be purchased over the counter (i.e., directly through a counterparty) or via an exchange (i.e., NYMEX) for some fuels and delivery locations. Over-the-counter options are customizable with respect to the price index used for settlement, meaning that a local price index can be used to reduce or eliminate basis risk (see Info Box: Basis Risk). European- and American-style options that are indexed to the New York Harbor No. 2 heating oil futures contract (the diesel fuel correlate) and RBOB gasoline (the gasoline correlate) can be obtained on NYMEX where they have significant open interest and trading volume in near months, but are more dif- ficult to obtain for further out months. These contracts are available to cover up to 36 consecutive forward months with 60 predetermined strike prices ranging from 1 to 60 cents above and below the at-the-money strike price (the current price of the desired month’s futures contract).12 4.1.1 Caps The most straightforward way for a transit agency to hedge with options is to purchase call options to create a synthetic cap on upward price movements. When the spot price exceeds the strike price of the call option at maturity, the transit agency can exercise the option and receive the difference between the market price and the strike price. The transit agency would continue to pay the higher market price for its physical fuel supply. However, if the hedging plan is structured properly, increased expenditures on physical fuel purchases would be offset by payments to the agency from the seller of the call option, which creates a synthetic cap on the agency’s fuel price. Regardless of the spot price, the buyer of the call option pays the seller a premium. This means that the maximum effective fuel price that the agency will pay is equal to the call option strike price (the cap) plus the premium. At all prices below the strike price, the buyer does not exercise the call option and simply pays the market price on its physical fuel plus the premium to the option seller. Figure 4.1 shows the performance of a 24-month string of call options with a strike price of $2.75 per gallon and a 20-cent premium versus a hypothetical range of future prices. The hori- zontal dashed line in Figure 4.1 indicates the call option’s strike price, the black line represents a hypothetical range of spot prices, and the solid lighter line represents the price paid by the transit agency (the minimum of strike price and the spot price, plus the fixed 20-cent premium). For example, if the market price rises to $3.25 per gallon, the call option pays out $3.25 – $2.75 = $0.50 per gallon to the buyer. However, the net gain to the agency is 50 cents less the 20-cent pre- mium, or only 30 cents per gallon. When prices are lower than the strike price, the buyer simply pays the market price for fuel plus the 20-cent premium. 12“Heating Oil Options: Contract Specifications.” CME Group Website. http://www.cmegroup.com/trading/energy/refined- products/heating-oil_contractSpecs_options.html#prodType=AVP (April 14, 2011).

Hedging with cap-Price instruments 25 Source: SAIC Time Unit Figure 4.1. Cap: gains and losses versus hypothetical market (spot) prices. Info Box: Options Pricing The premium on an option contract is determined by a mathematical formula that estimates the probability that the option’s strike price will be above the spot price at maturity. A widely used formula for the pricing of European-style options (options that can only be exercised at maturity) is the Black-Sholes formula. This for- mula is mathematically complex, but essentially prices options (either puts or calls) based on five factors: 1) the current price of the underlying asset, 2) the strike price of the option, 3) the volatility of the underlying asset, 4) the time to maturity of the option, and 5) interest rates. Applying the Black-Sholes formula, Figure 4.2 shows how the premium for a 12-month European-style call option decreases as the strike price increases. The prices are calculated assuming that the spot price for diesel is $2.50 per gallon, volatility is 15%, and the interest rate is 5%. Figure 4.2 shows that the premium on an at-the-money call option (a call option where the strike price is equal to the current spot price) would be approximately 22 cents per gallon. In other words, if a transit agency wished to hedge itself against any upward movement in prices it would cost the agency 22 cents for each gallon hedged. Thus, the effective maximum price would be the strike price of $2.50 plus the 22-cent premium, or $2.72 per gallon. If the spot price at maturity falls to $2.40 per gallon, then the effective price paid would be $2.40 + $0.22 = $2.62 per gallon. The option premium is also sensitive to two other important variables: oil price volatility and the time until maturity. Figure 4.3 shows the calculated premium of a diesel call option under different volatility environments (5%, 10%, and 15%) and at varying maturities (1 to 24 months forward) given a current spot price of $2.50 per gallon, a strike price of $2.75 per gallon, and an interest rate of 5%. (continued on next page)

26 Guidebook for evaluating Fuel Purchasing Strategies for Public transit Agencies Options Pricing, cont’d Source: SAIC, OptionTradinngTips.com: http://www.optiontradingtips.com/pricing/free-spreadsheet.html “At-the-money”: Strike Price = Spot Price at Initiation Figure 4.2. Twelve-month European-style call option premiums by strike price when spot price is $2.50, interest rate is 5%, and volatility is 15%. Source: SAIC, OptionTradingTips.com: http://www.optiontradingtips.com/pricing/free-spreadsheet.html $0.00 $0.04 $0.08 $0.12 $0.16 $0.20 $0.24 $0.28 $0.32 $0.36 $0.40 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 Pr em iu m ($ pe r G all on ) Maturity (Months Forward) 5% 15% 25% Volatility Figure 4.3. Call option premiums by maturity and volatility environment when spot price is $2.50, strike price is $2.75, and interest rate is 5%.

Hedging with cap-Price instruments 27 Source: SAIC Market Price Cap Price Floor Price Agency Price $1.50 $1.75 $2.00 $2.25 $2.50 $2.75 $3.00 $3.25 $3.50 10 11 12 13 14 15 16 17 18 19 1 2 3 4 5 6 7 8 9 20 21 22 23 24 Gains versus market price Losses versus market price Time Unit Figure 4.4. No-cost collar: gains and losses versus hypothetical market (spot) prices. Figure 4.3 shows that the call option premium increases when volatility is higher because greater volatility increases the probability that the strike price will be higher than the spot price at maturity. The premium for a call option with a strike price of $2.75 and a maturity 12 months in the future has a price of .01 cents per gallon when volatility is low (5%), 10 cents per gallon when volatility is moderate (15%), and 20 cents per gallon when volatility is high (25%). At all volatility levels, options prices increase with time to maturity because longer timeframes give volatility more of a chance to work, thus increasing the probability that the strike price will be above the spot price at maturity. In a high volatility (25%) environment, the call option premium increases from roughly 1 cent for the one-month forward option to 36 cents for an option with a maturity 24 months in the future. Options Pricing, cont’d 4.1.2 Collars Collar strategies are designed to reduce or eliminate the expensive premiums associated with traditional caps by foregoing some benefits when prices fall. A collar is composed of a combination of call and put options that create a price ceiling and a price floor. These contracts allow the buyer’s fuel prices to fluctuate within a band, providing protection on the high end and allowing full par- ticipation in price declines up to a certain point. If the price ceilings and price floors are structured properly, a collar may not require the buyer to pay premiums. This type of instrument is called a no-cost collar. Figure 4.4 shows the performance of employing a 24-month, no-cost collar with a cap of $2.75 per gallon and a floor of $2.20 versus a hypothetical range of future fuel prices.

28 Guidebook for evaluating Fuel Purchasing Strategies for Public transit Agencies 4.1.3 Participating Cap A participating cap is similar to a collar in that both strategies offer ceilings on upward price movements and trade away some benefits from falling prices in order to reduce or eliminate premium costs. Rather than employing a firm price floor like a collar strategy, a participating cap trades away a percentage of every downward price decline. The result is an instrument that creates a firm cap on upward price movements and allows unlimited, but partial, participation in downward price movements. If structured properly, a participating cap may not require a premium payment. This type of strategy is called a no-cost participating cap. The participation rate—the percentage of fuel price declines that the transit agency enjoys— will depend on a number of factors, including the level of the price ceiling relative to the spot price (i.e., how far out-of-the-money the strike price is). Raising the price ceiling will increase the participation rate if price declines. Figure 4.5 shows the performance of a 24-month, no-cost participating cap with a strike price of $2.75 per gallon and a 50% participation rate versus a hypothetical range of market prices. 4.1.4 Price Corridors A price corridor is an options strategy that reduces but does not eliminate premiums by only capping prices up to a certain point. As with a traditional cap, a price corridor places a ceiling on price movements above a specific price. Under the price corridor strategy, however, prices are only capped up to a certain point, beyond which they are permitted to keep rising. If structured properly, this strategy reduces the premium payment required under a traditional cap-price options strategy and provides the buyer with adequate price protection under most price scenarios. However, the Source: SAIC $1.50 $1.75 $2.00 $2.25 $2.50 $2.75 $3.00 $3.25 $3.50 10 11 12 13 14 15 16 17 18 19 20 1 2 3 4 5 6 7 8 9 21 22 23 24 Agency Price (incl. participation) Cap Price Floor Price Market Price Gains versus market price Losses versus market price Time Unit Figure 4.5. No-cost participating cap: gains and losses versus hypothetical market (spot) prices.

Hedging with cap-Price instruments 29 strategy does not give full protection under extreme price scenarios. Figure 4.6 shows how the price corridor would perform versus the market over a 24-month period given a hypothetical range of market prices. 4.1.5 Advantages The biggest advantage of cap-price instruments over forward-price instruments is that they permit greater flexibility to customize a transit agency’s fuel price risk profile. Forward contracts simply lock-in a price over a set period of time and provide profit when prices go up and losses when prices go down. By contrast, cap-price instruments, such as those that can be created with options, allow transit agencies to limit exposure to upward price risk while at the same time benefit from favorable, downward price movements. Although this win-win risk profile requires a premium, it allows transit agencies to more carefully customize their hedging strategies to their operations. Additionally, innovative use of options strategies can reduce or eliminate premium requirements. The ability to take advantage of falling prices is an important consideration for transit agen- cies. Often, a transit agency must report to and be held accountable to its board of directors, state and local governments, and the greater public. Many of these stakeholders do not fully understand why an agency chooses to hedge its fuel prices and are suspicious of the financial instruments used to hedge. If these stakeholders learn that the agency is significantly overpaying for its fuel compared to the market price, support for the agency’s hedging program may waver. Hedging with options that allow an agency to take advantage of falling prices can help a transit agency avoid public backlash and encourage continued support for the hedging program. Source: SAIC $1.50 $1.75 $2.00 $2.25 $2.50 $2.75 $3.00 $3.25 $3.50 10 11 12 13 14 15 16 17 18 19 20 1 2 3 4 5 6 7 8 9 21 22 23 24 Agency Price (inlc. participation) Purchased Cap Price Sold Cap Price Market Price Losses versus market price Gains versus market price Time Unit Figure 4.6. Price corridor: gains and losses versus hypothetical market (spot) prices.

30 Guidebook for evaluating Fuel Purchasing Strategies for Public transit Agencies Hedging with options avoids adverse basis risk (see Info Box: Basis Risk), even if the options used are based on a price index that does not always closely track local prices. Adverse basis risk is less of an issue with call options because options contracts never lose and can only pay out money when exercised. Like all financial hedging instruments, options can be bought and sold independently of the physical fuel contract, thus allowing the agency to continue its best practices for fuel procurement. 4.1.6 Disadvantages Hedging with options is an extremely costly alternative. Several agencies interviewed for this guidebook had considered cap strategies at some point, but decided against them due to their extremely high cost relative to other hedging strategies. Options prices are driven by several factors (see Info Box: Options Pricing). A 12-month-forward, European-style call option in a moderate volatility price environment could cost roughly 10 cents per gallon, compared with fees of 0.1 to 0.15 cents per gallon for futures contracts and 1 to 5 cents per gallon for OTC swap contracts with similar maturities. Furthermore, call options typically require premiums to be paid upfront on all the contracts purchased. Funding this large, upfront cash premium may be a difficult task for a transit agency if cash is not readily available. However, premium costs for cap-price instruments can be reduced or eliminated through the use of innovative cap-price products, such as collars, participating caps, and price corridors. A related disadvantage is that premiums for long-dated call options are much more expen- sive than those for short-term options, which limits the time horizon over which an agency can affordably hedge its fuel consumption. Even in low volatility price environments, longer-dated options are expensive because they give volatility more time to work. The buyer of an option can only benefit from increased volatility because it increases the probability that the option will be in-the-money at maturity. This heavy premium on longer-dated call options makes it impractical to use options strategies for longer-term hedging strategies. Although no-cost options strategies, such as collars and participating caps, could theoretically eliminate some of the cost-related disadvantages of hedging with options, no transit agency interviewed for this guidebook has had experience employing them. This may be due to the inherent complexity of hedging with options. Some hedging advisers that work with transit agencies believe that options are generally good products for hedging in terms of the risk pro- files that they allow the buyer to create, but believe that employing such strategies is difficult in practice. Many transit agencies are suspicious of complexity and prefer hedging with more straightforward instruments such as futures or swaps. Some transit agencies interviewed for this guidebook expressed interest in using option strategies, but wanted to see how their experience with futures or swaps fared before moving on to more complex instruments. 4.1.7 Summary Table 4.1 summarizes the main advantages and disadvantages of hedging with over-the- counter options. 4.2 Web-Based Fuel Price Protection Programs An alternative to options for cap-price protection is to hedge with web-based fuel price pro- tection programs such as Pricelock, Fuel Bank, or MoreGallons. In discussing these web-based programs, there is no intent to promote one program over the other, or to promote the named

Hedging with cap-Price instruments 31 programs over other, unnamed programs. Rather, the purpose of this discussion is to provide a better understanding of how these types of programs work and provide examples of the ways in which they differ. The differences attributed to these programs in the discussion below are based upon the program descriptions at the time of this writing, and should be verified by anyone considering use of the programs. The price protection services offered by web-based fuel price protection programs differ, but in general, their niche is among operators of small and medium-sized fleets that do not have the minimum monthly fuel consumption to utilize other hedging instruments. These companies enter small-volume hedging agreements with many customers and then pool these hedging requirements to achieve volume that can be hedged in financial markets. The companies reviewed in this guidebook provide this hedging service for refined petroleum products, particularly diesel and gasoline. The value of these companies is to bring hedging products to small-volume consumers and to simplify the often complex process of entering financial hedging agreements. Each company maintains a user-friendly website with videos and articles explaining how the programs work, and provides online platforms that allow the user to obtain instant quotes and purchase protection. Figure 4.7 shows the price protection plan fee (i.e., premium) calculator on Pricelock’s website and Figure 4.8 shows the fuel savings spreadsheet on Fuelbank.com. All of the web-based price protection programs reviewed for this guidebook require customers either to prepay for fuel or to pay an upfront premium for price protection. After the customer has purchased coverage, the customer will never be obligated to pay money to the web-based program. The customer receives money from the program if the price exceeds the price cap, but does not pay money to the program when prices fall. By requiring upfront payments for service, these web-based programs avoid having to assess the credit risk of each user, thus making it Advantages Disadvantages Ability to take advantage of downside price movements and customize the agency’s price risk profile Adverse basis risk is not an issue Premiums can be avoided under certain options strategies (collars, participating caps, price corridors) High cost for caps compared with futures and swaps Extremely high prices for further-out options make long-term hedge protection prohibitively expensive More complex than swaps or futures and can be difficult for management to embrace Table 4.1. Options: advantages and disadvantages. Source: Pricelock.com Figure 4.7. Protection plan fee calculator on Pricelock’s website.

32 Guidebook for evaluating Fuel Purchasing Strategies for Public transit Agencies possible to extend coverage to any number of consumers regardless of volume. Although this type of protection is similar in nature to insurance, the web-based programs are not insurance products. Customers hedging with these programs do not need to submit receipts or fill out paperwork in order to be reimbursed when fuel prices increase. The web-based fuel price protection programs reviewed for this guidebook essentially provide products with risk profiles similar to purchased call options (caps). Although the types of protec- tion that these web-based programs provide are similar, there are several key differences. One important difference is the method in which the cap price and premiums are set: • Pricelock allows the customer to set its own cap price and choose a protection term ranging from 3 to 12 months. Pricelock charges a premium depending on how far out-of-the-money the cap price is and the length of the protection term. • Fuel Bank offers its customers fixed premiums for 3-month, 6-month, or 12-month pro- tection terms, but varies the cap price to fit those premiums to the market environment. During highly volatile price environments, the cap price will be higher than in a low- volatility market. • MoreGallons simply sets the cap price as the national average price on the day the protection is purchased (i.e., an at-the-money strike price). All fuel is fully prepurchased. While both Pricelock and Fuel Bank provide coverage for periods ranging from 3 to 12 months, MoreGallons offers an unlimited term of protection. However, unlike its two competitors, More- Gallons requires customers to fully prepurchase every gallon of fuel they wish to cover and charges fees for every transaction as well as an annual membership fee for joining the program. Fuel Bank and Pricelock, on the other hand, simply charge an upfront premium to cover their risks. Table 4.2 compares the characteristics of the three web-based price protection companies reviewed for this guidebook. Source: Fuelbank.com Figure 4.8. Fuel savings spreadsheet from Fuelbank.com.

Hedging with cap-Price instruments 33 4.2.1 Advantages Web-based fuel price protection programs that offer cap-price protection share some of the same advantages as purchased call options (caps). As with call options, web-based fuel price protection programs offer protection from upside price movements while allowing the buyer to enjoy the benefits of downside movements. Unlike options, however, web-based programs do not offer customized no-cost risk management strategies, such as collars or participating caps. The major advantage of web-based fuel price protection programs is that they allow small and medium-sized transit agencies to engage in hedging. These consumers typically do not have the minimum volumes to buy a single futures contract (42,000 gallons per month) or the required volumes to enter an over-the-counter swap agreement. In addition, these programs typically simplify the fuel hedging process, thus requiring less internal knowledge-building and manage- ment for transit agency employees. Furthermore, because these web-based programs are less complex than options, it may make it easier to convince the transit agency’s upper management and board to approve use of the program. Finally, as with other financial hedging strategies, web-based programs allow a transit agency to continue its fuel procurement best practices for its physical fuel supply contract. 4.2.2 Disadvantages Web-based fuel price protection programs that offer cap-price protection share many of the same disadvantages as purchased call options. As with purchased call options, the premiums for Pricelock Fuel Bank MoreGallons Instrument Type Cap-price Cap-price Cap-price Fuel Types Covered Gasoline, diesel Gasoline, diesel, jet fuel, aviation gasoline, marine fuel, heating oil Gasoline, diesel Minimum Monthly Volumes (gallons) 50 1 100 Protection Term 3-12 months 3, 6, or 12 months (longer terms available on request) No limits (pre purchased gallons never expire) Price Index US Dept. of Energy NYMEX or USDept. of Energy MoreGallons Price Index Cap Price Set by customer Set by Fuel Bank Price on day customer prepurchases Premium (cents per gallon [c/g]) Varies depending on strike price 3 months: 15 c/g 6 months: 20 c/g 12 months: 25 c/g None Other Fees None None Purchase fee: 6 c/g Cash-in fee: 6 c/g Annual Member fee: $79 Fuel Pre-Payment No No Yes Method of Payment Monthly settlements Monthly settlements Cash-in prepurchased gallons on website within 30 days of physical fuel purchase Sources: Pricelock: https://www.pricelock.com/ Fuel Bank: http://www.fuelbank.com/ MoreGallons: http://www.moregallons.com/ Table 4.2. Comparison of web-based fuel price protection programs.

34 Guidebook for evaluating Fuel Purchasing Strategies for Public transit Agencies hedging with web-based programs are extremely high relative to hedging with other tools, such as OTC swap or futures contracts. The premiums, which are paid up front to Pricelock and Fuel Bank, can be prohibitively high for a small, cash-strapped transit agency. MoreGallons does not charge a premium under its program, but does require the buyer to fully prepurchase all of its gallons and charges an effective fee of 12 cents per gallon hedged (6 cents for purchases and 6 cents for cashing in). Unlike Fuel Bank and Pricelock, MoreGallons is not quite a cap-price instrument in the tradi- tional sense. Because the volumes under the MoreGallons program are fully prepurchased, there is an incentive to use them at some point in the future even if the spot price is above the strike price. If a customer does not cash in its prepurchased gallons, the customer loses the full amount of the purchased gallon. However, the customer is not forced to turn its gallons at any specific maturity so it has the ability to decide when it wishes to cash in its gallons. Web-based fuel price protection programs expose the customer to counterparty risk. The customer trusts the web-based program to cover the risks it undertakes on the financial market. If the company running the web-based price protection program goes bankrupt, it is unlikely that the company will make good on its obligations to its customers. Web-based hedging products are generally standardized in terms of the index used for refer- ence pricing, thus introducing basis risk, particularly for transit agencies in markets where the fuel price does not correlate well with the index price used by the program. However, adverse basis risk (the risk that the customer will lose money on physical purchases and its hedging instrument) is not a serious concern because the instruments do not lose money when prices fall. Nonetheless, opposite movements in the local physical fuel price and the price index used by the web-based program could lead to a situation where the hedging program is ineffective (i.e., the customer loses money on physical purchases, but the hedging instrument does not offset the loss). 4.2.3 Summary Web-based fuel price protection programs are an attractive option for small and medium- sized transit agencies that do not require adequate amounts of fuel to hedge directly using finan- cial markets. In exchange for an upfront payment, these programs allow the transit agency to protect itself against price increases while still benefiting from downward price movements. However, web-based price protection programs are more expensive on a per-gallon basis than hedging with financial products, expose the customer to counterparty risk in the event that the protection provider goes bankrupt, and expose the customer to some degree of basis risk that could lead to ineffective hedging (see Table 4.3). Advantages Disadvantages Sm all and medium-sized fuel consumers can use these programs Ability to take advantage of downside price movements Adverse basis risk is not an issue User-friendly websites take the complexity out of hedging and may make it easier to obtain management approval Extremely high cost on a per-gallon basis compared with hedging directly with financial products Counterparty risk exists with price protection provider Basis risk may lead to ineffective hedging Table 4.3. Web-based fuel price protection programs: advantages and disadvantages.