The JSE Diesel Hedge: Protecting you against fluctuating prices

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The JSE introduced Diesel Hedge Futures and Options to its range of commodity derivatives in March 2014. Volumes traded since inception, stood at 97 176 contracts which is equivalent to 485,88 million litres as at 31 October 2018.

Why these DSEL hedge contracts?

These contracts (futures and options) allow investors to protect themselves against movements in the local pump price of diesel. The futures contract references the price of European Gasoil futures, as traded on the New York Mercantile Exchange, owned and operated by the CME Group.

The South African wholesale price of diesel is made up of two components, namely taxes and levies and the basic fuel price (BFP). Taxes and levies are set by government from time to time and cannot be changed. The second component is the BFP of diesel and is based on a basket of international gasoil products that are not tradable.

The JSE DSEL Hedge is therefore the best available instrument that can be used as proxy for the BFP, since it is tradable and it accounts for the exchange rate between the Rand and the USD. However, it is important to note that the JSE diesel contract that references international gasoil prices, only accounts for 93% of the variability in the BFP price and therefore does not offer a 100% hedge. Specific examples are provided in Table 1.

Table 1: Salient features of the JSE DSEL contract
Futures Diesel (European gasoil)
Trading system code DSEL
Trading hours 08:30 to 17:00 (SA time)

Admin period from 17:00 to 17:15.

(Monday to Friday except SA national holidays)

Contract months All twelve calendar months available, with the front consecutive six months always available. Other pump months are introduced on demand.
Contract size 1 contract = 5 000 litres
Quotations In SA Rand (ZAR) per litre
Minimum price movement 0,0005 ZAR per litre
Table 2: Important terminology
TERMINOLOGY
Pump month The pump month is the reference calendar month when, on the first business day of the month, the final arithmetic average cash settlement value is published based on the reset period. E.g. if December is the pump month, the expiry day will be 1 December 2018.
Reset period This is the calendar month prior to the pump month when no trading activity will take place for that month and where the arithmetic averaging commences in order to determine the final pump month cash settlement value. E.g. referencing a December 2018 pump month, the reset period will run from 1 to 30 November 2018
Last trading day This is the business day prior to commencement of the reset period. E.g. referencing a December 2018 pump month, the last trading day for this expiry will be 30 October 2018.
Settlement date Settlement will take place on the first business day of the pump month, taking into account the arithmetic average price taken over the reset period.

 

Hedging the basic fuel price

We indicated that the South African wholesale pump price is composed of the basic fuel price and taxes and levies. Since taxes and levies are fixed and any risks associated with these inputs are undiversifiable, we will focus on the BFP component whose price variability can be hedged using the JSE DSEL contract.

Consider BFP prices for 500ppm diesel. Table 3 gives the monthly percentage change in the BFP as well as the monthly percentage change in the JSE hedge contract since its inception. It is evident from this that the variability in prices from the two data sets, is quite similar. What is important is that the hedge eliminates directional risk, and what remains is basis risk emanating from the fact that the hedge is a proxy and only 93% correlated.

Table 3: Monthly percentage change in the BFP and monthly percentage change in JSE hedge contract.
Pump month Date BFP500 JSE BFP500 JSE DSEL
DSEL
17-Nov 31/10/2017 6.2363 6.1102
17-Dec 30/11/2017 6.8463 6.6301 -9.78144 -8.50872
18-Jan 29/12/2017 6.6263 6.3076 3.213415 4.86418
18-Feb 31/1/2018 6.4563 6.2788 2.565534 0.456592
18-Mar 28/2/2018 5.9863 5.7451 7.279711 8.500032
18-Apr 30/3/2018 6.0163 5.8317 -0.50114 -1.50737
18-May 30/4/2018 6.6063 6.4428 -9.80669 -10.4789
18-Jun 31/5/2018 7.4563 7.1388 -12.8665 -10.8028
18-Jul 29/6/2018 7.7163 7.3493 -3.48698 -2.94867
18-Aug 31/7/2018 7.6763 7.3921 0.518383 -0.58237
18-Sep 31/8/2018 7.6763 7.776 0 -5.19338
18-Oct 28/9/2018 8.9163 8.5967 -16.1536 -10.5543

 

For example, consider the April and May 2018 contracts highlighted in Table 3. If in April an investor realises that he needs to buy diesel in May, he would have two choices: either he waits until May and buy his diesel at the May going prices or he locks in a price in April for May.

The official BFP price jumped 9,8% from R6,0163/litre to R6,6063/litre. If the investor did nothing in April, he would incur additional cost of 9,8%. The corresponding JSE hedge contract increased 10,47% from R5,8317/litre to R6,4428/litre and so, if the investor had decided to buy the hedge, he would have covered his potential losses. This could have gone the other way of course, where the investor could have made a loss because of the mismatch between the hedge and the actual BFP price. However, this would still be a negligible loss compared to where he had not taken any hedge at all.

In conclusion, we could have a situation whereby the hedge outperforms, matches or underperforms the actual BFP price for the idiosyncratic risks mentioned above. It is important to remember that the strong positive correlation between the hedge and the BFP for 500ppm diesel, ensures price protection. Hedging against the fluctuating diesel price equips you to more prudently manage your diesel intensive business and the JSE Diesel Futures and Options enable you to lock in margins and manage costs. This allows you to fix the price at which you buy your diesel at a future date.

Deliverable diesel contract

The Commodities Team continues to actively reach out to potential hedgers, presenting the benefits of using the contract to manage their diesel price risk. To further improve the efficiency of the hedge, the JSE continues to explore enhancements to the contract.

By introducing a deliverable diesel contract, this remaining correlation issue would finally be resolved as participants will then be able to convert from a cash-settled hedging contract to a deliverable diesel contract where they will then receive the final settlement value at the published BFP price. South African participants will for the first time have access to a 100% correlated diesel hedging platform.

The deliverable diesel contract remains a work in progress and more information will be provided once we have actualised this proposition. That said, nothing prevents you from using the current cash-settled diesel contract to hedge out your volatile diesel prices.

Contact a JSE commodities broker to open up a trading account or email commodities@jse.co.za for more information about how to get started.

 

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