Indiana Launches a Fuel-Hedging Price Program to Aid Municipalities

CHICAGO - As local governments across the country struggle with rising fuel costs, Indiana is launching a gasoline and diesel fuel-hedging program designed to help its municipalities offset the growing expense.

The program comes as oil prices - though currently falling amid an economic downturn and market turmoil - have reached record highs over the last year, straining the budgets of local governments and transit agencies nationwide. By limiting exposure to open market prices, the program's advocates say it will reduce risk for governments and bring more certainty to annual budgets.

Indiana-based advisory firm Crowe Horwath LLP - formerly Crowe Chizek & Co. - and Chicago-based energy consultants Maverick Energy Consulting crafted the hedging program. The team launched a pilot program with Indianapolis last year and is planning a state-wide launch later this year.

The program allows local governments - through the Indiana Bond Bank - to hedge exposure to market prices by creating a swap with a counterparty that sets a so-called strike price for fuel, based on a commodity index. If the price rises, the counterparty pays the Bond Bank the difference between the higher price and the strike price; if the price of fuel falls below the strike price, the Bond Bank pays the counterparty the difference, probably from the savings on fuel purchases.

"The program is designed to hedge risk and uncertainty, and to provide certainty to local units of government with respect to their fuel budgets, and that predictability will allow them to be better at planning their resources," said Tom Guevara, who is managing the program for Crowe Horwath. "We're just bringing what are good financial private-sector practices into the public sector."

Because Indiana law prohibits local governments from entering individually into derivatives contracts, the Bond Bank - which does not face the same restrictions - will act as a conduit for participants, he said. Under the bank's administration, it will be structured as a pooled program, as many participating entities alone do not consume enough fuel to generate competitive bids, Guevara added.

"Indianapolis could do it by themselves because they have enough volume to be able to attract a diversity of bidders who might bid as swap counterparties," he said. "However, for other cities and municipalities, there aren't many that are large enough to do a program by themselves, so they have to find a way to combine their consumption, and then we can use that combined consumption to go out into the market."

As the first stage of the program, the finance team expects to work with about 10 of the state's largest cities, school districts, and counties. The Bond Bank's board is expected to approve final applications later this month.

Indianapolis entered into a seven-month gasoline-hedging contract in mid-2007. Working through the Indianapolis Local Public Improvement Bond Bank, the city used a so-called collar swap- providing for a price range - for a portion of its consumption, about 200,000 gallons of gasoline, and a fixed-price swap for about two months' worth of consumption. The city received $166,390 in net settlements from its swap counterparty for the year, according to Guevara.

The program is shaped by a variety of state and local laws - for example, state law restricts to one fiscal year the amount of time an entity can participate in the program. In order to curtail speculating, the program will limit all participants to hedging no more than 80% of their consumption level, Guevara said.

City councils will need to approve participation in the program, and though they are able to continue to deal with their current fuel suppliers, governments would not be able to enter into long-term fixed contracts with their suppliers.

The program is set to launch as oil prices have fallen to their lowest point in nearly a year. If that trend continues, the program may prove less attractive for governments, but Crowe Horwath expects that the current price decline, if temporary, will be a boon to the program.

"Government entities can take advantage of current market prices, as most have already budgeted higher, and this probably represents a low point in pricing over the next few months until the U.S. economy gets rolling again," Guevara said.

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