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Betting on oil


Leaking oil pipelines, tension in the oil-rich Middle East and hurricanes threatening rigs in the Gulf of Mexico all fuel the worries of businesses that rely on petroleum to keep their operations running.

Incidents such as the shutdown of production by BP Exploration Alaska Inc. can have an impact on the price and availability of gasoline, jet fuel, natural gas and other petroleum products in the same way weather and political conditions can influence pricing. Risk managers and financial executives are charged with finding ways to keep price hikes or shortages from affecting their operations and finances.

Their techniques for protecting themselves range from sophisticated financial instruments to common sense fuel conservation measures.

Long position

Large fuel-dependent companies such as airlines generally look to financial markets to hedge their bets by buying futures or other instruments to smooth pricing. The practice of locking in a price for a product to be bought at a later date is not without some risk, though.

"If you're a bona fide hedger" that needs to buy natural gas, unleaded gasoline or jet fuel, "you can use the futures market to protect yourself," said Phil Flynn, vice-president and senior analyst at Alaron Trading Corp., a Chicago-based futures and options broker.

"If you think prices are going higher, you can lock in today. But the risk is, if prices go down, you could have done a lot better" without locking in a price, Mr. Flynn explained.

Even so, he noted, securing a price for petroleum products means "you have peace of mind as to what you will pay" and allows for more predictable financial planning.

Iberia Airlines said it was able to use a hedging program to limit price increases on around two million tons of fuel it used in 2005. The Madrid-based airline holds contracts with banks that state a price for jet fuel, a spokeswoman for the airline confirmed. If the actual cost rises above that amount, the contracts are triggered and pay Iberia the difference.

Despite the arrangement, Iberia's fuel costs in 2005 reached €863.1 million, a 32.1% increase from the year before. That increase, though, is smaller than the 42% jump in jet fuel costs the airline would have faced without the hedging program, according to the spokeswoman.

Users of petroleum products aren't the only ones that can suffer from price or supply disruptions. Distributors at energy companies also prepare for that risk.

Crude oil and natural gas is largely supplied by Russian pipelines to MOL Rt., a Budapest-based oil and gas company. A short-term disruption in supply would not cause significant damage to the company's operations, according to Tibor Papp, MOL's head of group risk management.

"We still have some natural gas production in Hungary" and five storage facilities that could meet normal demands for about a month if the Russian supply was cut off, said Mr. Papp. A longer-term disruption would "definitely impair" MOL's ability to provide the product, he added.

As for petroleum, the company has several months'-worth of crude stored, said Mr. Papp.

Looking further ahead, MOL hasn't prepared for a day when crude oil will run out, said Mr. Papp. The company's "strategic planning horizon" is five to 10 years, not a time frame during which oil is expected to be used up, he said.

Future fuels

The end of oil is not an ongoing issue for Ceska ráfinerská, which operates refineries in the Czech Republic, said Hana Jilkova, the company's treasurer. The refinery is, however, ramping up its operation to blend ethanol as an alternative to petroleum, she said.

Fears of the oil supply drying up are unfounded, according to Charles Perry, president and chief executive officer of Perry Management Inc., a Midland, Texas-based energy consulting firm.

"Yes, we are running out of cheap oil," he said. "No, we are not running out of oil." But additional oil supplies probably will not be developed as long as oil prices remain at less than $100 per barrel, Mr. Perry predicted.

High prices fuel development and have other advantages, he said. "Mass transit will never be developed as long as gasoline is cheap because people will stay in their cars," Mr. Perry predicted. "There will be no conservation of gasoline until the price becomes painful."