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What Is Energy Hedging?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 23 November 2016
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Energy hedging is a type of investment strategy that involves the buying, selling, and holding of investments that have to do with the production of different types of energy. This can include stock and bond issues that are prepared and made available by companies associated with various types of energy, including petroleum companies, coal mining corporations, and even solar and wind energy companies. Like any type of hedge situation, energy hedging involves buying those investments at a certain price today with the expectation that when the future date for delivery arrives, those investments will be worth considerably more than the purchase price.

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One way to understand how energy hedging works is to consider an investor who chooses to purchase some type of commodity that is involved with energy production, such as the corn that is used in the production of biofuels. The investor will commit to purchase a certain quantity of corn at a specific price, with the corn to be forwarded to the investor on a delivery date that is six months in the future. Here, the investor is engaging in a hedge situation, since he or she is anticipating that the market price for that corn will be much higher in six months than it is today. If this proves to be true, the energy hedging strategy is successful and the investor can quickly sell the corn at that higher market price, making enough to pay off the seller in full and still enjoy a profit from the venture.

Using an energy hedging approach does require some effort on the part of the investor. There is the need to assess the quality of the commodity involved, making sure that finding a buyer later on will be feasible. In addition, the demand for the commodity, both present and future, must be accurately projected. Without a quality commodity to sell and a demand for that commodity, the hedging approach is not likely to generate much in the way of profits, and may in fact cost the investor money.

There are a number of different ways to select investments for an energy hedging strategy. Investors may focus on coal that is mined for use in the production of energy, invest in solar or wind energy companies, or even invest in offshore oil drilling as a means of securing assets that can be sold at a higher price at a later date. As with any investment activity, taking the time to assess the current price of the investment, consider the reputation of the seller, and accurately project what will happen to the price of the investment by the delivery date is crucial to successfully earning some sort of return for the effort.

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