Gas prices are on the rise again across the nation. Higher crude oil prices seem to be the big driver here which may be compounded in the near term by a weakening US Dollar on the international market. A falling dollar, rising inflation expectations and continued economic recovery are likely to lead to a strong reflation in energy prices including oil and gasoline prices. Consumers and investors may seek to hedge and profit from a rise in prices through ETFs in the market.
[VIDEO] How to Profit from Gas Prices
One of the great things about being an investor is that you can exercise more control over your overall financial situation than non-investors. This control extends beyond your portfolio and into the rest of your financial life.
A great example of what I mean by this is the ability to offset the damage high gasoline prices can do to your wallet. It doesn’t matter if you own a high mileage vehicle or not – higher energy prices will cost you money. This article is about one way to protect yourself against gas prices spikes in the future.
The United State Gasoline Fund (UGA) ETF is one tool that can be used to offset risk of rising gasoline prices. UGA replicates the movements of gasoline futures available in the commodity futures market. UGA’s is designed to rise and fall with gas prices in the U.S. in equivalent percentage terms.
For example, in 2009 a gallon of unleaded gas moved from $1.60 to $2.53, which is a 58% increase. During the same period UGA rose in value 62% matching those price changes. Constructing a hedge against higher gas prices is relatively easy from here.
Estimate Your Future Gas Spending
Assume that at today’s prices you knew you were going to spend $1,000 over the next year on gas and you want to eliminate the risk of higher prices. You could buy $1,000 worth of UGA to offset the risk and effectively freezing the net price you will pay for gas over the next 12 months.
What Happens If Gas Prices Rise?
Assume that prices rise 50% and you actually spend $1,500 on gas over the next year. Your investment in UGA has also risen in value and the profits from UGA should approximately offset the extra expense.
What If Gas Prices Drop?
By hedging your projecting gas expenses you have reduced the risk of higher prices but you have also eliminated potential savings from a price drop. If you wind up spending less on gas over the next 12 months because prices fall, the losses on your investment in UGA will offset those savings.
In the example above, you can see how a hedge works to eliminate risk of higher prices by essentially freezing the net price you will pay over the hedged period. However, reducing risk is not the only benefit of commodity ETFs like UGA. They also provide very flexible and convenient exposure to commodities for diversification.
If you believe energy prices (including gas) will continue to rise as economic growth continues, then an investment in commodities may be very attractive. ETFs like this eliminate the complexity of having to deal directly with the futures market and are accessible within a traditional stock and options brokerage account.
Image courtesy Barbara L. Hanson.