There are also other examples of how to hedge a chemical plant or power plant, as well. In the early 2000’s I started a trading strategy of playing ethane to natural gas spreads as far out I could build the portfolio. I always wanted a long-dated economic trading book, and this fit perfectly. So perfectly it was like building NGL plants without investing a dime.
How?
The fixed cash cost of Ethane production from NG at that time was ~$.02/CPG. And, guess what the forward curve was, yes sir, two cents per gallon.
Since this spread did not include the variable cost, I knew it was a matter of time that some ethane plants would shut down or the economics would turn.
Therefore, I went out into the paper markets and started buying all the ethane swaps I could get my hands on. But, there was little liquidity beyond a few months. I wanted to, and had the authority to put on 10 years’ worth, if I could get it done.
I was able to get an NYC bank to sell us 36 months of financial swaps, and I quickly sold NG to create this fixed cash-cost synthetic asset.
The broker, by the way, who got this done said it was the best day he had ever had in 20 years. Yes, he sent a couple of us some nice holiday gifts, and we never disclosed them because we ate the evidence.
That ethane vs. natural gas margin in recent years has gone from 2/CPG to 35/CPG, back today to, coincidentally, around ~2/CPG. Add variable of another 2-3/CPG, and ongoing column maintenance work, and it is 7-8/CPG to make any money. The pendulum swinging too far, again, as it will in any and every market again in the future.
Get long that spread!?
Looking back today and one can see, if unfamiliar, that NGL plants, the midstream plants, have done extremely well the last 5 years. We all have had brilliant ideas that never materialized, but you can see the opportunity to think differently about hedging.
Hedging can be maximizing by going long a spread that makes one even longer in their own natural or synthetically created positions.
Vertical Integration
Said another way, if you own a Polyethylene plant that is ethane feedstock based, you can further vertically integrate your business through this frac spread of NG to ethane. It ensures that you can take yourself back to the wellhead, where it all begins for chemicals, and will continue so for decades and decades, and a century most likely.
The point is that if you look at not just the micro-level, immediate risks, or react to shocks, and think about hedging in terms of how to optimize your financial position in a way that risk is good and is an opportunity, not a cost, and this mentality will change how you design hedges that fit your risk/reward profile.