Football Chance Blog

Presented here is the method I used to calculate my Form 1040 taxes using the Schedule K-1 information received for my USO shares.

DISCLAIMER: This information is provided for information purposes only. It is not intended to constitute tax advice which may be relied upon to avoid penalties under any federal, state, local or other tax statutes or regulations. The rules are complex. As always, you should consult with your tax advisor regarding the application and impact of these rules on your particular situation.

Part III line 1

Ordinary business income (loss) - Reported amount: ($5)

Since United States Oil (USO) is a Publicly Traded Partnership (PTP), the ordinary business income (loss) reported on Schedule K-1 follows special rules.

Losses from a PTP may not be used to offset passive income from any other source. Each PTP is treated separately, and a PTP loss must be carried forward and used only against future income from that same PTP. Losses are also freed up upon a taxable disposition of all PTP shares.

Form 8582, Worksheet 3 and Worksheet 5 were used to keep a record of my unallowed loss reported for the USO shares this year. Each year, the unallowed losses will be carried forward until they are either offset by income, or until all of the USO shares are sold.

I will report on the method of treating this loss, as it applies to my fuel hedge, at a later date.

Part III line 5

Interest income - Reported amount: $57

The reported amount was added to all of the other interest income reported on Form 1040, Line 8a.

You must fill in and attach Schedule B if the total interest on Form 1040, line 8a is over $1500 or any of the other conditions listed at the beginning of the Schedule B instructions apply to you. The reported amount is then entered on Schedule B, Part I, Line 1.

This was the easiest reported entry to understand.

Part III line 11C

Sec. 1256 contracts & straddles - Reported amount: ($474)

The tax treatment of ETFs investing in commodity futures is different. For USO, gains (losses) can be realized throughout the year as positions are rolled or liquidated. In addition, at year-end, the value of the futures positions are treated as section 1256 contracts and are “marked-to-market.” Gains or losses on these contracts are then realized as 60% long-term and 40% short-term. Unlike ETFs that hold securities, gains or losses may be realized each year even if the shareholder does not sell the ETF.

Use Part I, Line 1 of Form 6781, Gains and Losses From Section 1256 Contracts and Straddles, to report the gains and losses from all section 1256 contracts that are open at the end of the year, or that were closed out during the year. This includes the amount shown in box 11C of Schedule K-1. Part I was completely filled out. No other parts of Form 6781 were used, since they did not apply to me.

Under the marked to market system, 60% of the capital gain or loss will be treated as a long-term capital gain or loss, and 40% will be treated as a short-term capital gain or loss. This is true regardless of how long the USO shares were held.
Enter the net amount of these gains and losses on Schedule D (Form 1040). Short-term gains or losses are included with the amount reported on Schedule D, Line 4. Long-term gains or losses are included with the amount reported on Schedule D, Line 11. Include a copy of Form 6781 with your income tax return.

Part III line 20A

Investment income - Reported amount: $57

The reported total investment income included on lines 5, 6a, 7, and 11A, of Schedule K-1 is reported here. This total is used in the calculations for Form 4952. If you itemize deductions using Schedule A (Form 1040), then the Investment Interest deduction reported on line 13 of Schedule A (Form 1040) is calculated using Form 4952.

The reported amount, of investment income, is entered on Form 4952, Line 4a. If Form 4952, Line 3 is zero, then Form 4952 does not have to be completed since you will have no interest expense deduction to report on Schedule A, Line 13. Include a copy of Form 4952, if it is used, with your income tax return.

I do not itemize deductions, so I did not need to use Form 4952, and I did not use the reported amount.

CUMULATIVE ADJUSTMENTS TO BASIS

Sales of USO shares are treated the same as any stock sale and are reported on Schedule D. The length of time that the shares are held determines whether the capital gains are long-term (greater than one year) or short-term (one year or less).

The Schedule K-1 “2006 SALES SCHEDULE” has a “cumulative adjustments to basis” (col 5) for each sale of USO shares made during the year 2006. This amount should be combined with the normal basis (cost+commission+fees) and used to determine the gain/loss to be reported on Schedule D. The IRS only checks the sales proceeds from transactions, so adjusting the cost basis will not cause any discrepancies.

Example:
I bought 52 USO shares on 6/16/2006 for $3401.64 (3396.64 + 5.00 commission). The cost per share is $65.41615. On 7/17/2006 I sold 3 shares for $212.04 (217.05 + 5.00 commission + 0.01 fee), and entered this sale price on Schedule D, Part I, line 1(d). The cost for the 3 shares is $196.25 (3 x 65.41615). For these shares, the “cumulative adjustments to basis” reported in the 2006 Sales Schedule, supplied by USO, is $8. The adjusted cost basis of the 3 shares is $204.25 (196.25 + 8.00), and I entered this “Cost or other basis” on Schedule D, Part I, line 1(e). The gain from the trade was $7.79 (212.04-204.25), and I entered this gain on Schedule D, Part I, line 1(f).

The instructions specify that an explanation of the basis must be attached if the actual cost is not used. A simple solution is to attach a filled 2006 Sales Schedule received from US oil. At the bottom of Schedule D. write “See Attached Schedule 1.” At the top of the 2006 Sales Schedule, label the form as Schedule 1 and include your name and social security number. Supporting statements are assembled in the same order as the schedules or forms they support, and attached last.

The adjusted basis should be entered into financial software such as Money or Quicken. Then when the information is passed to tax software, the basis will be correct.

Technorati Tags: USO, taxes, schedule k-1

On June 16, 2006, 52 USO ETF shares were purchased at a cost of $65.32 per share, for a total cost of $3396.64. The initial distribution of the shares is shown in my August 10 post.

Since the last results report, sales were made on September 18 and October 24. The gas hedge calls for USO share sales around the 16th of each month. Since September 16 was on a Saturday, the share sale was made the following Monday. The October sale was eight days late since I was changing stock brokers, and the share sale was made at the first opportunity.

The results of my gasoline and heating oil hedge, to date, are shown in Table 1, which is in PDF format.

Table 1:Hedge Results - Four Months

GAS HEDGE
Four gas USO shares were sold on September 18 at $58.49 per share, for a net loss of $27.32. My gas usage for the previous month was 48.993 gallons. Dividing 48.993 gallons by 25 gallons per USO share called for a sale of 1.960 shares. Since the ratio of the number of gallons of gasoline to one USO share should not be changed during a hedge, that ratio remained at 25. My estimated usage called for a sale of three hedge shares and two speculative shares. Those five shares, and the +1.182 share carryover from the August share sale, and the present residual of
-0.040, called for selling 6.142 USO shares. Since my usage was below my estimate, two shares were sold to cover my actual usage, one speculative share was sold to reduce their number, and the extra share that had accumulated due to lower than actual usage was sold. Two USO speculative shares were not sold, leaving a residual of +2.142 shares to be carried over to the next sale. The two speculative shares will be sold later during the hedge, since the hurricane related event they are used to protect from did not occur.

Calculation of the carry over:
hedge shares (3) + spec shares (2) + previous residual (1.182) + present residual (1.960 - 2) - shares sold (4) = residual (2.142)

Three more gas USO shares were sold on October 24 at $52.98 per share, for a net loss of $37.02. My gas usage since the last sale was 82.344 gallons. Dividing 82.344 by 25 gallons per USO share gives 3.294 shares. My estimated usage called for a sale of two hedge shares and one speculative share. Those three shares, and the +2.142 share carryover from the September share sale, and the present residual of +0.294, called for selling 5.436 USO shares. Since my usage was above my estimate, due to a longer time between sales and an increase in mileage, three shares were sold to cover my actual usage. The October speculative share was used to cover this actual usage. The two carried over speculative shares were not sold, leaving a residual of +2.436 shares to be carried over to the next sale.

Calculation of the carry over:
hedge shares (2) + spec shares (1) + previous residual (2.142) + present residual (3.294 - 3) - shares sold (3) = residual (2.436)

Thirteen of the original 26 gasoline shares remain.

OIL HEDGE
No heating oil delivery was made during this period.

Twenty-one of the original 26 heating oil shares remain.

An analysis of the results will be made in my next post.

Technorati Tags: USO, hedge results, oil hedge, gas hedge

Gas prices have decreased dramatically in the last couple of months, which is wonderful news for all consumers. However, back in June, I locked in my gas usage at a price around $2.75 per gallon. So am I sorry I did? Not at all!

If gas prices hold at their present level until next June, I will lose two to three hundred dollars on my gas hedge. Still, the drop in crude oil prices (and gas prices) has contributed to the present strength in the stock market. Part of the increase in stocks has been attributed to the drop in the price of crude oil, and I figure that part has increased the value of my stocks by two to three thousand dollars. I am very happy!

I would like to see gas prices drop even further. If prices continue to drop, or hold at these prices, that will be great for the economy, the stock market, and the consumers’ pocketbook. If gas prices drop another twenty-five cents, gas prices will be at the same level as two years ago, when the price of a barrel of crude oil was around $42.

Is this a good time to set up a gas hedge? To answer that, we must consider a few things:

1. The largest oil deposits are mostly in countries that historically have had a rocky relationship with the United States. The potential for a supply disruption, at any time, is definitely possible.
2. A reason to hedge gas is to protect against hurricane related price increases. This year was about as good as it gets, with few hurricane related problems. But what about next year?
3. Many emerging economies have increased their demand for gas. Their increased demand is increasing at a slow but a steady pace, which will limit how low gas prices can go.
4. When the cold weather arrives in December, some upward pressure, on crude oil prices will occur.
5. “Big Oil” likes President Bushs’ policies, and may be trying to help the Republicans in the upcoming elections, by manipulating the market. Following the election, we may see some increase. (I had to throw this in, since some people attribute the timing of the decrease, in gas prices, to President Bush and/or the Republicans.)

From these considerations, it seems that this is a good time to implement a gas hedge. “Bottom fishing” for a lower price can be dangerous, since rallies can be explosive. Doing a hedge after a sharp increase in prices is usually not a good idea.

Since my gas hedge has eight months to go, I can only hope that gas prices stay low, so that I can lock in these lower prices next June. But in eight months a lot can happen.

Technorati Tags: gas prices, gas hedge

The standings to date for the NFL 2006 season Grand Prize winners are now available on the Football Chance website. To go to the Football Chance website, click on Football Chance Home in the right side navigation bar. From the home page, the standings can be accessed from the left side navigation bar, in the first large rectangular yellow box.

The standings to date following each weeks’ play is available in two formats:

1. A list of the 496 tickets by position. The total points for each ticket and the corresponding ticket number are given.
2. A list of the 496 tickets by ticket number. The total points for each ticket and the corresponding position are given.

The two lists are given in PDF format, allowing any or all of the pages to be easily printed. Standings will usually be updated Tuesday.

The presented lists are for fundraisers that use the entire season. I cannot make lists for fundraisers that only use part of the season, since the weeks used can be variable. If a part season is used that starts with the first regular season games, then the existing list can be used.

Standings are given for a full set of tickets. I cannot remove unsold ticket sequences, since that can vary from user to user.

The next version release of the software will generate the lists shown on the website, and will generate correct lists for a partial or a complete season. The software will also remove unsold ticket sequences, if the next closest sold ticket is paid, when displaying Grand Prize winners for the weekly preview. The software presently removes unsold ticket sequences , if the next closest sold ticket is paid, when calculating Grand Prize winners at the end of the regular season. The software also presently indicates, at the end of the regular season, if an unsold ticket was not paid when using the “unsold tickets not paid” option.

I may change the structure of the website page from the PDF listings to an Interactive Server Page (ASP). The user will be allowed to enter their ticket number and get their position without looking it up, in the list, by ticket number. A selection button will allow printing either or both lists. This change will be made if it is feasible.

Technorati Tags: Grand Prize, position, ticket number

Commissions are a fixed, and sometimes significant, expense associated with hedging personal fuel use.

The following is an excerpt from my July 14 post:
“In order to minimize the effect of commissions, the broker with the lowest commission must be used. My commission this year is $5 per trade, because I was with Brown & Co. before they were acquired by E*Trade. I suspect that at the end of the year, my E*Trade commissions will increase, and I will have to switch brokers. Scottrade seems to be a good alternative. They have $7 internet trades with no minimum number of trades per quarter.”

I have decided to switch stock brokers, but instead of using Scottrade, I am going to use Interactive Brokers.

The following excerpts are from a July 31, 2006 article available on BusinessWeek Online at the following address: http://www.businessweek.com/magazine/content/06_31/b3995118.htm:

“Talk about cheap: At Interactive Brokers, a stock trade costs 0.5 cents a share, with a minimum of $1 a trade. That’s below what most institutional investors pay. The catch is that the firm charges a $10 monthly maintenance fee if you don’t spend at least $10 trading. But for many investors, the $120 minimum annual cost is well worth it. According to the J.D. Power survey, the average online investor made 36 trades in 2005, up from 23 in 2003. Even at Scottrade, 36 trades amounts to $252 a year, more than double Interactive Brokers’ $120.”

“For active investors, the margin rate — what it costs to borrow from the broker to leverage your holdings or sell stocks short — may also be an important factor. Every broker has a tiered pricing system for margin loans, with larger amounts getting the best rates. Here again, Interactive Brokers has the best deal: just 7% for borrowing of $100,000 or less and as low as 5.5% for $3 million or more.”

“A few years ago, when interest rates were lower, no one would have taken note of the rate a broker paid on cash balances. But now, with short-term rates more than four percentage points higher, yield can influence where you choose to take your business. A yield difference of just one or two percentage points can amount to thousands of dollars a year depending on the amount of cash you have in your account. On balances of $10,000 or more, for example, Interactive Brokers pays 4.8%. Accounts with less than $10,000 earn nothing. At Scottrade, $1 million accounts get a 4.3% yield, while those with under $1,000 earn only 1.8%.”

“Perhaps the best broker for the money is Scottrade, where a stock trade costs just $7, period. Scottrade charges only $17 for a mutual fund trade, vs. $35 at many brokerages. Those trades are free if they involve one of Scottrade’s 893 no-transaction-fee (NTF) funds. Still, what gives the company an edge over even lower-cost competitors is its 272-branch network, with offices in 47 states. If you’re having any kind of problem, instead of waiting to reach a call center, you can drop into an office. The combination of low cost and extra service has earned Scottrade the J.D. Power customer satisfaction award for six years in a row.”
————————————————————–

Interactive Brokers (IB) is not for everyone, especially if you make many trades where the share amount is greater than 1500 shares. Then the commissions would be cheaper at Scottrade. At IB, you must make one to ten trades per month, depending on the number of shares involved, to meet their $10 minimum. For stock and ETF trades, IB charges $0.005 per share, with a minimum commission of $1, and a maximum commission of 0.2% of trade value. Here are some examples of IB commissions:
100 Shares @ USD 50 Share Price= USD 1.00
1,000 Shares @ USD 50 Share Price= USD 5.00
1,000 Shares @ USD 2 Share Price= USD 4.00
2,000 Shares @ USD 50 Share Price= USD 10.00

Interactive Brokers will work well for me, since my trading is usually 1000 shares or less. For USO ETF fuel hedge trades, where the number of shares is very small, the commission will be the minimum commission of $1. I will not have a problem reaching the $10 minimum per month, since I plan to write covered calls on 1000 shares of a stock. IB has great commissions on stock options. IB requires its customers to spend a $10 monthly activity fee minimum which may include commissions, market data fees, and other fees. Those customers spending less then the activity fee minimums in any given month will be charged the difference.

I will hold off on my next USO share sale until the broker transfer is completed, and then I will have to restate my previous hedge results to reflect the new brokers’ fees.

Technorati Tags: commissions, Scottrade, Interactive Brokers

CORRECTION TO CALCULATOR

Commissions
The calculated commissions were based on the assumption that both gas and heating oil was being hedged. The commission was split evenly between the two hedges. If only gas or heating oil was being hedged, half the commission was being used. That made the effective lock-in price lower than it should be. The calculated commission has been changed to use the entire commission when only one fuel is being hedged.

If both gas and heating oil are being hedged, the commissions are distributed proportional to the number of gallons being hedged. The result is that the commissions are the same for both gas and heating oil.

DIFFERENCES FROM BLOG ENTRIES

Interest
In my blog entry about interest costs (July 17), the interest was calculated on the entire dollar amount hedged, and split equally between gas and heating oil. The calculator computes the interest costs separately for each hedge.

Taxes
In my blog entry about buying extra shares to cover taxes (July 20), the extra shares necessary to pay taxes on the hedge shares was calculated, and then the necessary extra shares, to pay taxes on the extra tax shares, was calculated once. The calculator computes the necessary extra shares, to pay taxes on the extra tax shares, five times. That makes for a much better approximation when a large amount of fuel is hedged.

The USO ETF fund, from a tax standpoint, is a limited partnership. That means that in any year where the fund realizes any sort of gain, shareholders will get a form K-1 (instead of the 1099 that applies to most investments), and must pay taxes on those gains. Those taxes are due even if management holds true to its plan, and make no distribution of the money. It remains to be seen if losses will also be reported, on the K-1 form, thus giving shareholders a reportable loss on their income tax form. I will examine that more closely during tax season early next year. No allowance is made for anything reported by the fund, since it may be negligible.

My Hedge
In previous blog entries, I used 540 gallons as my estimated annual use. The actual number of gallons, represented by the shares I purchased, is 525 gallons. Also, the actual gas speculative share percentage in my hedge is 25% (not 20%), and the heating oil spec share percentage is the same at 5%. It would appear that I overestimated my gas usage, so I may have at least a couple of shares that will become spec shares.

Technorati Tags: USO, USO ETF, calculator, commissions, interest, taxes

I now have time to blog again after spending more than three weeks researching and buying a new car. I bought a 2007 Toyota Matrix XR that is being custom ordered from the factory. The car will have anti-lock brakes (ABS), side-impact airbags, extra value package #2, all weather guard package, and my choice of color.

The NFL football season is now well under way, with the third weekend of play over. The first distribution of winners’ checks was made last week (Sept. 20). No distribution was made after the first week since too many tickets were still outstanding. Most of the sold tickets are now in.

The number of tickets my Rotary Club wants to sell this year is 400. We have achieved that goal, so any tickets sold above that amount is extra profit for the club. By selling 400 tickets, we make $4000. With a sellout of the 496 tickets, we make $5000. Our club has dwindled in size to about twenty-five active members, so a sellout of the full set of tickets is not as easy to achieve as when we had 35 active members. My Rotary Club is in a small town of 800 residents, with about half the members coming from surrounding small towns.

I thought about listing the winning tickets online, for an NFL-BASED fundraiser, but that would not be feasible since so many prize combinations are possible.

The software right now cannot give a Grand Prize Preview of the total point standings to date. I have been asked about that and I agree that it would be a nice feature. I will examine the feasibility of incorporating it into the software. If I do, the feature will be available in a software update.

While manipulating the Regional Settings in my computer, I discovered that the local currency set, such as the dollar, pound, or euro, is properly displayed everywhere, in the Football Chance software, except the Prize Structure page. Since the Prize Structure page is only used to decide the prize payouts, the software can be used, as is, to run a fundraiser using other currencies. In a future revision, I will fix the Prize Structure page to display the correct currency symbol.

Of interest as a fundraising idea, a nearby (15 miles away) Rotary Club does their major fundraiser using a raffle ticket format. They sell 600 tickets for $100 each, pay back $30,000, and make $30,000. The winners are drawn at a buffet dinner and dance, where each ticket purchaser is allowed to bring one guest. Fortunately for them, many ticket buyers entitled to attend do not, so food costs are greatly reduced. The cost of the dinner and dance is subtracted from the $30,000 payback, and the remaining money is returned as prizes of varying amounts. Also, the ticket purchasers are eligible to win various prizes donated by local businesses. A few of the nicer donated prizes are raffled off in a separate raffle, at the dinner, to generate additional profit. This is a nice method for a larger club in a city where the club has access to a hall with cooking facilities, and where members can supply the dinner to keep costs down. This method is not feasible in my small town, where selling many tickets for $100 each would not be doable. We are happy with our smaller fundraiser.

Technorati Tags: Rotary Club, NFL, football, fundraising idea, ticket

This calculator uses all of the elements, discussed in my previous posts, to determine how many USO shares are necessary to implement a fuel hedge. I would suggest reading previous posts for complete information about each element.

This calculator is a browser-based interactive form. It has been checked with the Mozilla Firefox 1.5 browser, and has also been checked out with two versions of the Microsoft Internet Explorer 6.0 browsers.

The calculator can be accessed by clicking on the link below. It can also be accessed on the navigation bar, to the right, under “Important Links.”

USO ETF Share Calculator

Constraints of this calculator:
1) One year hedge only.
2) “Calculator generated distribution” is spread evenly throughout the year. There is no ability to store a general, user defined, annual profile.
3) “User defined distribution” allows the user to enter their annual estimated use as shares only.
4) Results cannot be stored. Print your results. When the browser is exited, all values entered or calculated will be lost.

Pressing “Enter” after typing in a number is the same thing as clicking on “Calculate.”

The calculator is best viewed with a “Normal” text size in Firefox 1.5 or with a “Smaller” text size in Internet Explorer. To do this, from the View menu on the top menu bar choose View=>Text Size and select “Normal” or “Smaller”.

I have tried to make the calculator error free, but I am sure someone will discover an error or a way to make it fail. If any errors or problems are encountered, please leave a comment to this post. If it is within my capability, I will fix it.

Printing Calculator Results
Printing the results can sometimes be a problem if your browser does not “Shrink To Fit” the page before printing. Newer browsers like Firefox 1.5 and Internet Explorer 7.0 do, so printing the calculator results is not a problem with those browsers.

Always do a preview before printing, so you can see what the page layout will look like. To do this, from the File menu on the top menu bar choose File=>Print Preview. If the right side of the page is cut off, in the Page Setup box (choose File=>Page Setup), select the Shrink To Fit Page Width or Fit To Page button. Then choose File=>Print.

For browsers that do not support “Shrink To Fit,” if you print the page in Portrait (vertical) mode, the right side of the page will be cut off. To print the entire width of the page, choose Landscape (horizontal) mode from your printer menu. To do this, choose File=>Page Setup and select Landscape. Then choose File=>Print. Always return to Portrait mode, from your printer menu, after the calculator results have been printed.

Technorati Tags: share calculator, printing results, portrait, landscape

As you may have noticed, my fuel hedges, for both gasoline and heating oil, are doing well. I would like to remind everyone that the purpose of a hedge is to lock in fuel prices at a fixed price, and not to do better or worse than that fixed price. There will be times, due to various circumstances, when the hedge actual results will be a little higher or a little lower than that fixed price, but the ideal result is to purchase fuel at the initial lock-in price.

GAS HEDGE RESULTS
My gas hedge, after two months, is at an actual cost of $2.554 per gallon. Since my effective lock-in price is $2.861 per gallon, the lower actual cost is attributable to the following two reasons:

1) The speculative shares have lowered my cost. As mentioned previously, one spec share was sold in July, and one spec share was sold in August. My purchase of USO shares in June was made when crude oil was near $69. At the July sale, crude was near $76, and for the August sale crude was near $75. That increase in the value of the spec shares lowered my actual cost by thirteen cents per gallon. The increase in the price of crude oil is why I sold two of my five spec shares. However, these two spec shares were sold early in my hedge. Over the full twelve month hedge period, the two spec shares will lower my actual cost by only two to three cents per gallon.

2) The price of gas at the pump has not increased as much as the increase in the price of crude oil. Can you believe that? Of course, the pump price also will not drop as fast as crude oil prices. There is a “lag” in the pump price when crude oil prices increase, and also when they decrease. Over time, that should increase my actual costs to a price closer to the lock-in price.

HEATING OIL RESULTS
My heating oil hedge, after one delivery, is at an actual cost of $2.431 per gallon. The eight cents per gallon difference with my effective lock-in price of $2.515 per gallon is due to the same circumstance as reason #2 for gas. The dealer price has simply lagged the price it should be at by eight cents per gallon. My actual cost will probably approach the lock-in price when the dealer price lags are averaged across deliveries.

The lag in crude oil price versus retail prices is caused by the processing and distribution times. The refinery must process the crude oil it purchased at a specific price. Finished product is then shipped by pipeline to a primary distribution point, transported to a secondary distribution point, and then trucked to the retail outlet. So the fuel at the retail level should be lagging the reported prices of crude oil by two or three weeks. Of course, during hurricane Katrina, prices reacted much more quickly to crude price increases and anticipated shortages. The retailers claimed they had to raise their prices immediately, so they would have the money available to buy the more expensive fuel they would be receiving. It was just a coincidence that they made a “windfall” profit from the low-priced fuel in their tanks.

GENERAL COMMENTS
When an oil company is setting up a pre-buy plan for its customers, they have a problem in making sure that they will make a profit at the pre-buy price. Although the pre-buy must usually be paid for within 30 days of receipt of the contract information, oil prices could move up during that month and affect the price at which they can lock in. If the oil company wants to make a specific profit per gallon, then they must set the pre-buy price higher to protect themselves. Of course, if the oil price remains stable or goes down during the payment period, then the oil company will just make a larger profit.

A guest speaker at my Rotary Club, from a local oil company, made an interesting point about pre-buys. He said that during abnormally cold winters, when oil prices generally increase, their profits are reduced. Their hedge method delivers an amount of oil, each month, that will cover a typical winter season. However, during a winter that is colder than normal, oil usage is higher, so they must buy higher priced oil on the open market to cover the increased demand. If the price of oil drops after their customers pre-buy amounts are used up, which tends to be the normal scenario, the oil company will lose some of their profits. He did not say that if the price of oil remains the same after their customers pre-buy amounts are used up, the oil company will not lose any of their profits. He also did not say that if the price of oil continues to increase after their customers pre-buy amounts are used up, the oil company will make higher profits. This is one situation I know of where the oil company can lose some money, and cannot completely protect themselves from the loss.

The bottom line is that the pre-buy customer sees an inflated fixed price. That is because the oil company hedge, and also my personal hedge, is made in the dynamic environment of world markets, so the effective lock-in price is variable. The oil company protects itself, from a possible higher lock-in price, by setting the pre-buy price higher.

In my next post I will present my “USO Share Calculator.”

Technorati Tags: USO ETF, USO hedge, hedge analysis, Rotary Club

On June 16, 2006, 52 USO shares were purchased at a cost of $65.32 per share, for a total cost of $3396.64. The initial distribution of the shares is shown in my August 10 post.Sales were made on July 17 and August 8. The gas hedge called for an August sale around August 16. I received an oil delivery on July 31, so to keep the oil sale close to the delivery date, the gas sale was moved up a week. With the small amounts of fuel I am hedging, incurring only one commission expense for the month saves money. Since the oil bill is mailed, there will always be some delay from the oil delivery date.

If an oil delivery should occur within a week after a gas sale, a separate sale should be made for oil. Then, the commission loss would be subtracted from the USO profit (or loss) for that sale.

The results of my gasoline and heating oil hedge, to date, are shown in Table 1, which is in PDF format.

Table 1: Hedge Results - Two Months

GAS HEDGE
Three gas USO shares were sold on July 17 at $72.35 per share, for a net profit of $21.09. My gas usage for the previous month was 57.254 gallons. Dividing 57.254 gallons by 25 gallons per USO share called for a sale of 2.290 shares. Two USO shares were sold, leaving a residual of +0.290 shares to be carried over to the next sale. Because of the increase in the price of crude oil, in late June, due to the Israeli-Hezbollah conflict, one speculative share from the August allocation was sold.Three more gas USO shares were sold on August 8 at $71.47 per share, for a net profit of $18.45. My gas usage since the last sale was 47.295 gallons. Dividing 47.295 by 25 gallons per USO share gives 1.892 shares. Adding the previous sale residual of +0.290 shares called for a sale of 2.182 shares. Two USO shares were sold, leaving a residual of +1.182 shares to be carried over to the next sale. The remaining August speculative share was also sold, since the price of crude oil was still high, and the share is primarily to protect against hurricane-caused price increases, which had not occurred.

The residual is 1.182 shares because three USO hedge shares had been allocated for August. Due to the earlier than normal gas sale, the actual number of gallons used is lower than my estimated use, and one estimated share was not used. I am not prepared to declare this share as “excess,” and thus a speculative share, until more time has passed.

OIL HEDGE
Five oil USO shares were sold on August 8 at $71.47 per share, for a net profit of $30.75. The oil delivery was for 137.1 gallons. Dividing 137.1 gallons by 28 gallons per USO share called for a sale of 4.896 shares. Five shares were sold, leaving a residual of -0.104 shares to be carried over to the next oil sale.

An analysis of the results will be made in my next post.

Being worked on is a “USO Share Calculator.” The calculator is a browser-based interactive form. Enter your values on the form, and the number of USO shares to buy will be calculated. Distribution of the shares to sell is either computer generated, or user supplied based on estimated usage.

Under consideration is software that will simplify the entire hedge procedure.

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