The Hedge – An Introduction
“In the first task, almost inevitably is getting past this conversation.
Where do you think prices will be in one month, three month, one year periods?”
Hi, and welcome to this first episode of The Hedge, a podcast about risk management and volatility in energy markets.
The Hedge is an effort to bring more insight and industry expertise to our energy learning community.
We will take a varied approach to suit the needs of our diverse audience – from Hedging 101 to topics that any risk management professional can appreciate.
We look forward to any feedback on topics of interest to our audience, and hope to grow and improve along the way.
Topics:
- Blue Lacy LLC – One year in
- Help! I’m accidentally in the energy business
- Step 1 – Moving things in the right direction
Your Hosts
The Hedge is a collaboration between EKT Interactive and Blue Lacy Advisors, an energy risk management consultancy.
Blue Lacy Advisors is headed by Steve Sinos, a professional with 20 years experience in energy markets.
Our goal here at EKT Interactive is to bring expert voices and insight to our learning community. Doug Stetzer,VP of Content and Community at EKT Interactive will co-host this podcast with Steve.
Links and Resources
Blue Lacy LLC – Strategy and Risk Advisory
Transcription
Hey, everyone, Doug Stetzer here from EKT Interactive, and I’m excited to announce The Hedge, a new podcast with longtime friend and colleague Steve Sinos of Blue Lacey Advisors and Energy Risk Management consultancy.
I’ve known Steve for a long time and he’s one of those people that I just seem to learn a lot from whenever we talk. So I pitched him on the idea of recording some of our conversations and launching this podcast. He agreed, and I just really think our learning community will benefit from his experience and knowledge. And in return, I hope we can get the word out about Steve’s new company, Blue Lacey Advisors, and the risk management services that they provide.
Hedging 101
The Hedge will be a mix of conversations tailored for our Energy 101 audience, sort of the Hedging 101, as well as a discussion around solid risk management practices and how they are influenced by or react to current events, price volatility in the energy markets. So I think a lot of people in energy will learn a lot and get a lot out of these conversations.
If you’re already part of the EKT learning community, then you know who we are. So I thought I would mainly use this first episode to introduce Steve, and honestly, since he’s the expert in this field, you’ll find he does most of the talking.
I’m just here to hopefully not as stupid questions. We hope you enjoy these conversations as much as we do. So let’s get started with this first episode of the Hedge.
Yeah, no, I think we, you know, we’ve known each other a long time, so I think we tend to get into good conversations. This, sometimes I look back like you said, like, Man, I wish I was recording some of those nuggets, or at least taking notes.
And so I was excited to get it on, you know, get it recorded here and for sure to get the name out there. You know, Blue Lacey’s only a year old, actually, this is our year anniversary this week of filing with the state to have, you know, official recognition for tax purposes, <laugh>, and not coincidentally then, like, we’re putting together all of our different vendors, and then it was really been a nice reception so far, but still nobody knows, you know, like, it’s hard to say anybody knows who you are when you, when you just get started.
And so I was excited to be able to share it with some of your, with your regular listener, you know, and yeah, like I’ve been in, you know, so I think I’ve been doing this for 20 years now.
Started straight Outta school and, you know, you ask kind of like, what is, what is the niche and how do we find it? It was through these conversations, right? Like over time you would talk to people and it was, there were a handful of questions that just kind of never seemed answered in ways that were satisfying to our clients and more so those questions sort of always needed to be answered again, right?
And it’s not definitional stuff, like what is a put and how do you use it? What would you use it for? It’s more like, this thing happened today or this week or this month, and that, you know, makes me question whether my original strategy still makes sense now, what? Right. And, and that, I think they all boil down to that question sort of now what?
Right?
And Blue Lacey came about, just sort of a series of iterations, and quite frankly, I got tired of being laid off, you know what I mean? Like in the, in our world, you get laid off every couple of years, whether you’re doing well, you know, is sort of secondary to how the market’s doing. And, uh, by the end of 2013, I had been in the, in the industry for, for 10 years and been laid off three times and it was just kind of tired of it and needed a break.
I was physically, emotionally, and mentally exhausted, took a bit of the garden and leave, you know, they paid me to go away. And so I took advantage of it, put my dog in the truck, and traveled the middle of the country here and kind of came back thinking what I really liked about this industry I could do on my own.
Right. I didn’t need a major brand behind me to have these interactions. And so it’s been a total of about 10 years as an independent advisor and just in the last year, really truly on my own, with my own shingle, my own website, all that sort of stuff, paying the bills through the vendors, all that stuff on my own. And so, you know, it’s, it’s so far so good. It’s been exciting to grow and I think proving out the thesis we’ve benefited from timing a little bit.
The 10 years leading up to this year we’re rather boring, right? Right. Folks got low to sleep in a comparatively low-vol world, low cost world, high growth, you know, maybe some of the EMP guys struggle to make money because of that competitive aspect of it, that depressed energy prices. But now we’re in a high ball, high cost, high, high commodity price world that, um, it’s possible that across the value chain we have winners and losers, you know?
And so I think it was the best time. I don’t, I didn’t do it on purpose, but it was one of the first time in my career I think I benefited a little bit from timing. So <laugh>, we can run with it.
Yeah. And, and, and you mentioned something there that I just wanna like dig into just a little bit, man. And, uh, and it’s that word reactionary, like you were talking about, you know, talking to clients and they’re calling you after the fact, after something’s happened.
And I think that’s kind of gets to the heart of, of hedging services and, and the conversation that, that you probably have with people is, is shifting from a reactionary, you know, standpoint of like, Oh my gosh, you know, if you’re a consumer, you know, prices have doubled and it’s, you know, hurt my bottom line, or if you’re a producer, like, Oh my gosh, prices are falling and I, you know, I’ve gotta meet my dead obligations. Like, that shift from reaction to having a plan has gotta be, you know, a conversation.
You have a lot. And, uh, you know, is that accurate?
Like, is that how you would describe it? And, and what’s the kind of like the process for, for taking someone from one phase to the other?
Yeah. So you’re 100% correct, right? When people are thinking about their businesses, they plan in a spreadsheet world where prices, costs, revenues are all boiled down to dot point line items, right?
Oil’s gonna be 80 bucks, natural gas is gonna be seven, whatever it is, right? Diesel’s gonna be $2 and 50 cents, whatever it is. And they, and they’re like, Okay, this is good. Today looks good. Let’s exaggerate it a little bit just to be safe.
And banks are terrible at this too, right?
They’ve got their forecast prices and they’re like, Well, let’s just discount that by 20% just to be safe, right? And most of the time that kind of works and it really only kind of works, but for the most part it’s how people do it and they’re used to it, and so they’re comfortable with it, and then something goes wrong, something breaks, you know, like, man, this is now gonna be this huge problem if you would’ve called me before we could have prevented it, but let’s worry about that later.
How can we address this? And there’s no repairing a position, right? Mm-hmm. <affirmative>, once it’s broken, it’s broken. The question is, what can we do now based on what we know today to address the market as we see it, or our losses or gains?
Hopefully, if you’re lucky, there have been some gains, right? The, you know, to to, to make this part of the process.
And so often it’s not until year two and, you know, call it nine months in, you start thinking about the second budget year we work together to where you really are able to unlock value.
There’s a solid period at the beginning where we’re learning each other’s tendencies and needs and that can’t, in ways that can’t be quantified, right? Mm-hmm. <affirmative> be very easy for me to sit down with a huge consumer, right? FedEx just reported recently and made headlines because people tend to think of them as a bell cow for the economy overall, right?
It’d be easy for me to sit down with the CEO of FedEx and say, Here is how sensitive your business is to the changing price of diesel.
He probably already has an analyst internally that’s doing that. But the rest of the conversation is, okay, realistically, what is the price of diesel say about your business? What is the rate of change? Of the rate of change, right? So how quickly can things change based on what we don’t know, right?
And then how much of that do we need to think about as, as a strategy support mechanism, right?
Like their actual business isn’t going to change, they’re going to deliver packages and charge people for it mm-hmm. <affirmative> and they’re gonna hopefully make profit, right? It’s a rather thin margin.
And so there’s a, a risk that there, that, that their assumptions at the beginning right? Are quickly violated by something that changes on a daily basis and, you know, two to 3%.
And on an annualized basis, typical rule of thumb would be like 20 to 25%, but right now we’re talking about 45 or 50%, right? Right. So FedEx is three or 4% profit margin over the last few years, right? No tiling 12 months, very quickly goes negative if that component right isn’t addressed ahead of time.
And that usually, that conversation usually can’t happen until year two, unless the client had the foresight to sit down and, and be a little bit more introspective about what sensitivity analysis means, right? Get out of the spreadsheet and ask yourself in a scenario where diesel prices are rising in this example for FedEx mm-hmm. <affirmative>, it’s likely if not, you know, you know, it’s likely that their business is possibly improving, right?
Because there’s more demand for transport, possibly more demand for FedEx as services. So what is their true risk in that scent?
And how often then do those prices keep rising even after we’ve hit that peak growth?
That is, you know, the fee that FedEx, you know, falling revenues would suggest a turn in the economy, right?
And how do we manage that mismatch between the two mm-hmm. <affirmative>. And once you can get to that conversation and become part of the, part of the forward looking planning, right? Once you’re working with the fp a and the treasury analysts to do more than just manage someone else’s expectation of prices or fear of changing prices, you can really add a lot of value. And what it tends to do then over time is minimize that variation in your success metric.
Not just talking costs, but if you can minimize, right? If you’re talking about three or 4% profit margin for a company like FedEx mm-hmm. <affirmative>, how variable is it over time and how much more value does that company have if you reduce that variability?
And the same goes for an EMP company, right? Their profit margins are much more volatile as a result of being commodity dependent, right?
Devon’s most recent profit margin was something like 25%, 24%, but there were a string of years where it was zero to negative. You know what I mean? Like, and that’s, that wasn’t necessary, you know, it’s not necessarily avoidable, but it wasn’t necessary to have that level of volatility.
And it, you can boil it down to answering the question for each company, which would be different, right? Like, is how much variance in that margin is acceptable and how much do I need to spend or am I willing to spend to minimize that variance?
And sometimes it’s, you know, you come back and say, well, the variance is really only, you know, one or two percentage points, right? And the cost of managing that’s gonna be greater than that, so it doesn’t make sense.
But often it’s like, oh, the variance is actually quite wide and in those years where that profit margin would become loss, right?
Mm-hmm. <affirmative>,
I would want that insurance, right? Ne it’d be necessary to become, to stay an a going concern. And that tends to be easier to, to work with large consumers because they’re not in the energy business.
Help! I’m Accidentally in the Energy Business
I mean, they are by accident because, you know, sometimes, you know, the 35, 40 5% of their variable costs might be energy, but they wanna be able to take the amount of unknown and define it to only those risks that they can accept. It’s a little bit more difficult for EMP type guys or trading midstream type guys because they want the upside, there’s a, there’s an expectation for volatility there and sure they get beat up pretty hard when they’re, you know, when they’re only selling a hundred dollars oil and it’s $120 print, they get, they get beat up pretty hard in that sense. Yeah.
So there’s a, there’s, that’s, that’s another piece that’s hard to quantify, right? Can you, can you withstand that? And you know, but as a result, B and p companies, especially small private guys go out of business more often than, you know, transport companies like FedEx, the size of FedEx, right? So,
And that’s part of just knowing the client for sure. And that’s why everyone’s got a different need and including, um, you know, just the, not only, you know, whether they’re on the consumer or or producer side also, like you mentioned, whether it’s really ener if energy is their primary business or if it’s, there’s something that they’re really looking to manage maybe a little more tightly.
But then also within that even, you know, like you mentioned really kind of briefly there is, you know, maybe some of these smaller companies out there, they wanna just like stay in business right over the long haul and uh, and just keep spinning out, um, cash flows to, you know, either investors or even like, if it’s like a, a family, right?
And so, so one of the things that I just wanted to, there, there was two things in there that were kind of interesting to me.
Like first was, you know, I think it’s important for people to have realistic expectations. Obviously when you go in there, and I’m sure one of the first things you have to do is start really setting those expectations and this idea that it’s, that it’s gonna be a two year process to kind of get things in line, right?
Whether you’re starting from zero or if you are making kind of a strategy shift, or if you’ve just been doing things maybe incorrectly, you know, so what, like what is something you run into, you know, what are the first six months of that two year process, you know, for with a, with a new, uh, client for you?
What’s the first part of getting things going in the right direction?
Uh, yeah. So the first six months or even a year are necessary because you have to work through a couple of periods that are monthly or quarterly to understand their internal processes and their internal metrics, right? And their internal sort of expectations of how their annual or, or sometimes five year cycle is billed, right? Mm-hmm. <affirmative>.
So you, what I try to do is sort of build rapport up until the point where you can contribute to the budget conversation by picking out those things that they get worried about, right?
“And the first task almost inevitably is getting past this conversation, Where do you think prices will be in one month, three month, one year period?”
And often people will get frustrated with me, cuz my answer is always, I don’t know. Right? Right. And I laugh about it and when we give presentations at things like everybody wants to make a bet and everybody wants to be right, but the answer is just plainly, I don’t know.
And I’m not here to do that. If that’s what you want, you need to find, right?
Go find a CTA who’s gonna momentum trade you into the next a hundred dollars swing or, you know what I mean? Or a hedge fund guy who’s gonna tell you about this spread is mispriced because of these things.
The first very first thing, and sometimes it takes longer than others, is to get to the point where we have mutually agreed upon what it means to be conservative relative to risk. Mm-hmm. <affirmative> in managing volatility. Inevitably, those two things tend to be said, you know, by everybody involved, every stakeholder, right?
Whether it’s a small family owned oil company, like you said, that’s just trying to, you know, pay the five stakeholders forever or it’s a huge airline that’s just trying to make sure that you know, that uh, jet fuel prices don’t corrupt its business.
Those generic statements have had, I mean like, I don’t know that I could count the number of different definitions and I seem to keep learning new definitions for them.
So the first task is to show them what is volatility actually not academically, right? Not this annualized, you know, at the money implied volatility.
Just realistically, what does volatility mean to you, the client in your, you know, three statement accounting sheet summary and how much of it is due to things that are so far out of our control on a daily basis, right?
That we have to worry about them in risk management terms or which components of it are within our control from a physical procurement or marketing standpoint, right? Can we do something as small as reconsidering contractual terms for how we price something or the days on which we price it to better reflect your business?
And then a match our hedges to that and, and at each time, like it pulls farther away from or further away from anyone’s interpretation of the market into understanding the first order and second order risks within your portfolio based on the decisions you made strategically, right?
Your edge is in your strategic process, whether you’re developing a resource or executing a service, that’s your edge.
Your profit margin is based on your edge and your primary business. Mm-hmm. <affirmative>. So let’s not pretend to be market experts in ways that we could predict the market, right? That’s a fools errand.
Let’s talk about it using the vocabulary of your business and minimize it. And the easiest example I have, some of my, my best clients tend to be folks like airlines or, uh, transport authorities who have minimal opportunity to control their net revenue, right?
It’s competitive or maybe even regulated utilities are another great one, right?
And so the volatility inherent to even just a normal year, not even a year like this, where we have had all sorts of things, exaggerate volatility, right? Is, is it can be damaging to the, to the company company strategy.
And so the questions become well with how often do we need to check this, right? So it’s not what do we need to do? Where do you think prices are going? It’s, well, how often do we need to have a conversation about the prevailing market relative to what we thought the market would be six months ago when we started the fiscal year, and then having a plan along the way on how to re react to that, to, you know, sort of the old cliche, right? Keeping the ship between the shores, right?
Like all we’re trying to do is get down the river and we’re not entirely sure we have a broad idea that is going north to south, but we’re not entirely sure because of, you know, various things that change where exactly the shore is where those are gonna be.
So we need somebody looking out ahead at intervals that we can actually rely on to help us make choices, right? And so you, you figure out how often do we have those conversations, how far out do we need to think about it? And that then that dictates how much you need to do or with which instruments, right?
And that’s a process that is, is at its core, similar for every client, but has its own nuance because of differing budgets, tolerances for variance and expectations of success, right? And so that, you know, might be easier right now for an e and p company with a break even of, you know, even 60 or 75, right? To make some of those decisions to just be pure insurance buyers and forget about the cost.
Whereas, you know, a large transit authority is, you know, at even higher levels of stress given the high cost and high volatility of, of fuels where they may have to be conservative in ways that minimize that cost and at the expense of, of flexibility, you know what I mean?
And so, right, once you get it there, whether it takes a week or a year, you can start contributing to budgeting and strategic conversations, right?
Because you’re speaking the same language. You have this a, a, a united expectation of what it means to manage volatility and you’re the sort of right hand man to the, the dude, right?
The who is CEO or the treasurer, whoever it is you’re serving, you’re there to make sure that he’s right and when he is wrong, right? The pain of being wrong has been minimized in a way to where he’s still able to achieve his goals.
And so you can add so much value in that sense, being their niche market expert and supporting and execution, right? Because strategy’s easy, executing strategy’s hard, you gotta make it easier for them because it’s never gonna be easy in the true sense, right? It’s always gonna be different starting day two, you know what I mean?
From what you thought it was gonna be on day zero and by day 365, you might look back and think, I never would’ve guessed that we would’ve had a, you know, a pandemic, a war, a hurricane, which we haven’t had any hurricanes yet, but not gonna
Yeah, in the gulf, but you know what I’m saying, right? Like these things that are, each of them is unpredictable, but the fact that something’s gonna happen is predictable once you start getting that sort of idea that black swans, you know, aren’t, aren’t unpredictable in nature only in like, you know, in how they actually develop.
Like you can really start to, to help somebody create a consistently successful strategy. And that’s, that’s really where we, once you get to year two, sometimes you look, you know, they just sort of assume that you’re there to help and you don’t, you don’t even have to worry about some of the more basic conversations. And so you start thinking about how can we share this with new people within the firm, right?
Maybe they’re young guys that just joined or maybe they got transferred laterally into the system. Like how do we, you know, sort of incorporate them into this to make it a robust, reliable, consistent, repeatable process that’s, you know, that’s, that’s that’s the first six months to a year with any client and regardless of how experienced they are, because often we, it’s about closing the gap between how, you know, my brain is thinking about the words they’re saying and what they mean those words to be.
Well I think if they’re, I mean, if I could sum up anything, man, um, and you might want to go ahead and just put this on, on your website anyway, is, uh, that idea that, that the edge is in the process, right?
Like this getting everyone on board in the process of analyzing and setting up a plan and then executing on that plan.
Like you said, you’re not in the predictive business, you’re not trying to break either prices or the forces that might affect those prices, whether it’s natural disaster, geopolitical, or just kind of basic economic in that, you know, at the end of the day, everyone should sleep better at night if they’ve got a structure in place that makes them at least know that part of their budget is under control when something like this happens, right?
Yeah. Or I might even frame it to say like, we admit that we have no edge and so we’ve done something to minimize consequences of that. You know what I mean? Yeah,
Yeah.
Like, I, I think that’s really like the core of risk management is like you’re doing a business to make money. Like all of, of all of the things that can go wrong, we can at least, like you said, you can at least sleep well at night knowing that it’s not gonna be the change in commodity price that’s going to corrupt your business in the coming week or whatever it is, Right.
Week, month, quarter. That’s, Yeah. So I think that’s, it takes, you know, it takes a while to get to that point though cuz it’s a it for most people, like, they’re so used to, especially successful businessmen, right?
Like they’re so used to trading on an opinion, whether they frame it that way or not, right? They’re, I think I can do this thing better than you and I’m gonna go make money doing it, right? Right. And so you’re like, well we’re on the other side of that corn, like this little tiny corner of your business. We know you can’t do better than the market and the market will punish you through speed. So we need to prepare. Right? Right.
And so, yeah, I mean it’s, that’s def the process of incorporating that into your strategy is definitely where you find value.
You know, I want to kind of bring it to like a little bit of a wrap for just this introductory episode because otherwise we’re just going into another topic and, um, but, uh, but you know, again, like ending on that, that idea that, you know, that this is a, this is a long process,
There’s a learning curve to it, but that when you have these discussions, you know, there’s a, there’s, there’s a playbook to play from yet, but obviously everyone’s got their unique goals and in, um, challenges within that, that playbook, you know, is there anything like you just like to, to point out just to kind of wrap up this, this little intro, uh, you know, just anything you that, that came to mind with anything like just on, on what I just said about, you know, just getting this thing started?
Yeah, well I appreciate it. I always enjoy our conversations as, you know, feel like we’ve been friends long enough that, like I said, if we could capture ’em sometimes, like, oh, I need to turn that into some sort of, you know, blog or something to run with that. And if, and I, if you let me talk, I’ll talk forever so we can capture some of those and dive in.
Like, I’d love it man, cuz I know it’s much better for me to work through these things out loud. So I appreciate you giving me the opportunity to share some of, you know, some of my stuff that it’s, you know, I don’t know if I was tasked with it, I could ever just write it down and turn it into anything useful. So hopefully you guys find it useful to discuss it out loud with me.
Yeah, absolutely. I think, uh, I think people will get a lot out of these conversations, um, you know, when they’re dealing with these risks and they’re dealing with, you know, notoriously volatile markets and things that just seem to be getting a little bit crazier every day. So, um, let’s just, uh, we’ll wrap it up there for now, man.
I appreciate you, uh, connecting and making some time and, uh, you know, we will, we’ll talk again soon and, and really start outlining, you know, where we’re going with this, uh, with this podcast.
Sounds good. Thanks,
Man. All right,
Well I hope you enjoyed that conversation. As you can tell, there’s a ton of material to cover in the field of risk management, and I already have a ton of ideas on where to go for future episodes.
If you’re interested in learning more about ekt interactive energy learning community, be sure to visit ekt interactive.com where you’ll find our courses on everything from oil and gas to power and renewables.
We’d love to hear how we can help your team or new hires get up the curve fast with their energy knowledge. And of course, if you wanna learn more about Steve and Blue Lacey Advisors and their services, go check out their website@bluelaceyllc.com. Thanks a lot and we’ll talk to you soon.
