Wednesday, July 2, 2008

Energy Watch: Trimming the Hedges

Here's where we put the "capital" in CapitalClimate. Energy prices have been soaring well enough on their own lately (past $140 a barrel for oil), but what if tropical storm disruptions or an exceptionally cold winter put more upward pressure on prices? Despite all the complaining over heat and humidity around this time of year in the Nation's Capital region, the typical household in the area spends more on heating than cooling. The Big Boys can hedge by trading in the futures markets, but the prices there are heavily influenced by speculation.

Money Magazine's Jason Zweig, appearing recently on the Nightly Business Report, suggested a strategy that could be practical for the individual homeowner. His plan works like this: Take an amount roughly equal to your total seasonal heating bill and use it to buy shares in an exchange-traded fund (ETF) which is based on the cost of your heating fuel. (An ETF is like a mutual fund, but instead of being priced once a day at the close of the market, shares are traded continuously on a stock exchange.)

For natural gas, Zweig recommends the United States Natural Gas Fund (ticker symbol UNG), which began trading in 2007. A more recent market entrant is the U.S. Heating Oil Fund (UHN), which was launched a few months ago. Also launched recently is another hedge against growing household energy costs, the U.S. Gasoline Fund (UGA).

Expenses involved in this strategy include management fees of about 0.6-0.8% and commissions to buy and sell (now around $10 or less per transaction at many discount brokers). In the event of a gain, profits are subject to taxes at ordinary income rates for shares held less than a year and capital gains rates of 15% or less for longer holding periods. If the value goes down, you can use the money saved on your heating bill to hedge against future price increases. If you sell the shares at a loss, then the loss amount can offset gains from other investments or be deducted from other income up to $3000.

Image: 3-month chart of UNG from, via Fidelity Investments. Click to enlarge.

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