New hedging tool for biodiesel anticipated

By Susanne Retka Schill | December 21, 2009
Posted December 30, 2009

The new year may bring a new hedging tool for biodiesel producers, when a new trading instrument being proposed by the Chicago Mercantile Exchange (CME) Group receives approval from the U.S. Commodity Futures Trading Commission. Last year the group received approval for a new group of swaps for corn, wheat and beans and are seeking approval now for another set of swaps for soybean oil and palm.

For biodiesel producers, the new intercommodity trading instrument will allow hedging both feedstocks and biodiesel production in a more liquid market with a single swap contract that ties a soybean oil futures contract with a heating oil futures contract. John Stotts, director of agricultural trading for Infinium Capital Management LLC, explained that while a biodiesel swap does exist, "the volume and open interest are next to nothing. It looks like the ethanol market did five or six years ago." Infinium has become more active in the ethanol markets in the last few months, he added, and is closely watching the development of the new tools for biodiesel.

With biodiesel futures nonexistent and the available swaps thinly traded, many producers have turned to hedging their biodiesel production through the heating oil market, which is used globally as a proxy for biodiesel because of the very high correlation in the two markets. While not quite as large as the soybean or corn markets, the heating oil futures market is more liquid than soybean oil futures. "You have a lot of participants in the heating oil market," Stotts explained. "From the crude side, there are distillers and big oil that have a lot of participation-it's definitely more robust in open interest and traded volume."

A swap provides a cleaner hedge, tying a soybean oil futures contract with a heating oil futures contract in one. Swap contracts are listed monthly as compared to eight contracts for soybean oil or seven months listed for soybeans.

"My understanding is that, in the biodiesel community, there is even less active hedging going on than there is in the ethanol community," Stotts said. "Hopefully instruments like this will give brokers and marketers more substance to go to biodiesel producers and say, you should take a look at hedging your production in this fashion. Right now, they don't have an efficient way to do that."
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