What is the Weight of a Heating Degree Day?

Written on: October 10, 2022 by Jeffrey Simpson

Savvy fuel dealers have long been aware of the dollar value of a heating degree day to their business. With this realization, many have purchased a weather-hedging product over the years to protect their vital margin in the event materially warmer-than- normal weather could impact a heating season. Most of a typical company’s fuel and service costs are fixed in nature. However, 2022 has introduced a wave of inflationary factors that have driven up these fixed costs, effectively loading up each heating degree day your company will experience this Winter with heightened significance.

In addition to the fuel and equipment supply issues, which have escalated the cost of goods sold just as we approach the peak heating season, expenses associated with payroll, insurance, repair, maintenance and fuel have notably mounted. The borrowing costs associated with tanks, inventory and customer receivables are expected to grow markedly this Winter if the current pricing trend persists.

Many will-call customers may opt to order only the bare minimum needed to make it through the Winter, yet your fixed costs continue. In the span of less than a year, the earnings burden on each heating degree day between November and March has become far more pronounced than at any other time in recent history. With these pressures, it stands to reason that target margins on fuel sales, service and installation can and should be raised, but that “X-factor”—the weather—still looms.

Weather-impacted business
This leads me to the odd question posed at the outset. With each of this coming Winter’s precious heating degree days now stacked higher with the costs of operating your business, have you paused to determine your company’s true required weather-driven earnings?

Fortunately, by using your budget or even last year’s results (if you have opted to navigate these unprecedented times without a forecast), a reliable figure can easily be assessed. While fuel oil and propane deliveries are most obviously impacted by warmer than normal weather, our clients’ experiences show service and installation activities tend to fall as well during periods of material warmth. Therefore, it pays to assess your reliance on each weather-impacted business line.

To many, weather hedging remains a bit of a mystery; however, it is merely a financial tool designed to replace some or all of the lost profitability that would otherwise have been earned in a “normal” heating season. By isolating the most weather-dependent gross profits and comparing them to the expected heating degree days for the same period, a gross profit per heating degree day target can be determined and used to establish protection.

Weather hedges are derivatives and can be structured in a variety of ways and at different protection levels, but the most typical approaches are designed for monthly or seasonal protection. Your commodity trading advisor can assist you in finding the approach that best suits your risk and discussing the costs associated with each approach.

As the recessionary indicators mount, increased bank scrutiny of borrowers’ 2022 financial results is likely to follow. For companies that seek to take advantage of acquisition opportunities, maintaining consistent performance is paramount. Lost heating degree days are shaping up to carry an outsized impact on financial performance this heating season.

Take the time to assess the full weight of what each heating degree day will mean to your company this year. By exploring the tools available to you to help insulate your company during this tumultuous time, you very well could eliminate the need for even heavier decisions next year. ICM

Jeffrey Simpson is the Managing Director of Angus Finance and acts as an advisor to the fuel industry in the areas of hedging, budget preparation, cash flow management, capital structuring, acquisitions, the location of financing and banking negotiations. He can be reached at 860-299-3358 or jsimpson@angusenergy.com.

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