No crack spread rocket science. Not even one of those handshake deals with the felons down at the local Shell station. Here’s how it works:
Base assumption: You run one car that chalks up 12,000 miles a year, at an average 20 mpg, using 600 gallons of gas a year. With regular unleaded anywhere from $2.65 to $2.85 around here over the weekend, let’s call it $2.75, and let’s call that the average price for the next 12 months. Total annual fuel cost: $1650 (600 gallons @ 2.75 a gallon).
We’re also going to assume, for the sake of argument, that the ratio of the price of crude to the price of gas at the pump is a constant which:
* It’s not, because pump prices tend to go up faster than they come down (funny that), but
* At the current crude price, of around $67.50, it’s 25 -- i.e. a barrel of crude is 25 times the price of a gallon of gas.
If the price of crude goes to $85/bbl – that would be a Goldman Sachs’ minispike – the average price of gas goes to $3.46, and your total fuel bill increases by $427.78. However, because you bought 25 shares of USO at, say, $68.00 and those shares are now worth $85.00, the $425 profit in your brokerage account puts you more or less square on the deal right there.
Of course, if the price of oil finally bends to the beliefs of Bob Marcin [paid sub. req., but for what, in his case, I’m not sure] and goes to, say, $45.00, you’ve got a $575 hole in your brokerage P+L. (If you’re still with me here, the math is 25 shares times the loss of $23 each).
Offsetting that, however, your annual gas bill has declined by $550 because you’re now paying – thanks to the decline in crude prices – just $1.83 a gallon for gas. Assuming the crude:gas price ratio stays in the same ballpark.
Go ahead. Plug in your own numbers. Be the Southwest Airlines of your ‘hood. Your mileage will vary, but even if you’re running up 25,000 miles a year in a Lincoln Navigator, the hedge seems to need less than 100 shares.
[Tiresome arguments about trading costs, slippage, and taxes will not be entered into. Just modify the assumptions... it’s a crude hedge, OK?]