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Wednesday, February 24, 2010

Hedging the Gas Price

I just bought a new car which I intend to keep for the next 8 years (got the extended warranty).

I was thinking - how can I lock in a gas price for that time? To be more specific, how much would it cost to prepay my gasoline for the next 8 years?

I estimate that I will need 4,000 gallons to cover the next 8 years. How could I achieve this?

One approach - buy 4,000 gallons today and store it. How much does it cost to store that amount?Does gas spoil, evaporate when stored? Presumably you can get a discount if you buy that amount. Let me investigate that approach later.

Next approach is to find a financial asset whose price is closely correlated to the gasoline price at the pump. This is quite difficult. There are ETF's that track the Oil Price, but these do not necessarily correlate with the retail gasoline price. This chart (courtesy of GasBuddy) shows the oil price compared with the retail gas price is San Jose, CA.

The retail gas price could change as a result of tax changes. In fact, as an aside, I think that taxes on gasoline should be dramatically increased. This should encourage conservation, while increasing revenues for underfunded government. Check out this link.

So, how can I create a hedge that includes tax changes? Back to the idea of the 4,000 gallon tank!

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