The Synthetic

Around the year 2010, an energy trader sat in my office and asked me this question, “Don’t you think we can create a financial hedge for liquid asphalt?” I kind of chuckled and said, “No way!” But I could never get the question out of my head. When I began to ease out of my job for retirement, I had time to apply myself to the question. It dawned on me that if a hedge could be created it would have to have two qualities. One is I had to be able to have a comparable relative value of the asphalt to backtest the hedge and the other is that the hedge would need to be composed of financial energy products that are traded at high volumes. You want liquidity in a hedge in case you want to get out. So it dawned on me that I could use coker values as the comparable value because it is the value of asphalt expressed as other products (pet coke, gasoil, naphtha, propane, etc. Now, these products met the criteria of having value, but they are not highly traded in the energy financial markets. I then put on my engineering hat and did some mass balance equations and studied relative BTU values and was able to create an equation that uses energy products in certain combinations and proportions to produce an asphalt value. I call this “The Synthetic”.

Click chart to see full screen

I back-tested the synthetic against 13 years of published coker alternative asphalt values and ran a Pearson analysis (r) to see how well the two data sets correlate to each other. The value came out to 0.988041 (meaning the synthetic correlates positively and almost perfectly) and the synthetic calculated values were above the coker values in every instance (See graph below). In other words, the model never predicted a value below the published value. To me, this adds a degree of confidence when either producing a financial outcome or predicting a future price, whether up or down. I think in the near future, coker values will provide the floor for wholesale asphalt pricing.

I am offering this idea to the asphalt industry in two ways. One is through The Asphalt App available at the Apple App Store and Google Play (search for “Asphalt Unlimited”). Go to the App Store and search “Asphalt Unlimited” and it will pop up. The app gives a prediction of future asphalt prices up to 18 months into the future based on yesterday’s energy market closing prices. The user selects the time period and a particular geographic region of interest and the app presents the calculated prediction.

The other product is an actual asphalt financial hedge. We procure financial energy product futures in accordance with the synthetic formula. If energy prices rise and the procured hedge goes “in the money”, the financial market will offset losses incurred in the physical asphalt market. Imagine being able to bid today’s cash price plus the cost of the hedge instead of guessing at some future price that doesn’t interfere with a low bid process! If the market goes the other way, the financial loss is capped at the cost of the hedge and the hedge holder is paying less than the bid in the physical market.