Hedging Oil Consumption

A US Gulf coast oil refiner refines 500,000 barrels of Oil per month into Gasoline and Heating Oil. It is concerned about the possibility of rising oil prices and the potential effect on its production margins should it be unable to pass on the higher coststo consumers.

They would like to hedge the risk of higher oil prices over the next yearby using CME Group Light Sweet Crude (LSC) futures and have asked you to evaluate their hedging choices.

Light Sweet Crude (LSC) daily price history (Source: Reuters)

Light Sweet Crude (LSC) futures are traded on CME Group at www.cmegroup.com and prices and further contract details can be found here. Abridged contract specifications are given below.

1. Explain how futures could be used to hedge the risk faced by the oil refiner.

2. How many futures and which delivery months should be bought or sold to hedge the risk?

3. Are there any additional risks and considerations to be taken into account when using futures to hedge a position like this?