Biodiesel hedging under binding renewable fuel standard mandates

Abstract

We apply an encompassing framework to assess the viability of hedging spot biodiesel price risk for four U.S. markets with a conventionally used heating oil futures contract and a soybean oil futures contract based on the logic that supply shifts (i.e., price of soybean oil as an input) drive biodiesel prices when binding blending mandates are in place. Results indicate that soybean oil futures should in fact be part of a composite hedge, and that in some instances greater hedging weight should be placed on the soybean oil futures contract than the conventionally used heating oil futures contract. • Biodiesel price risk is often hedged with heating oil futures, since biodiesel substitutes for heating oil in diesel blends. • But binding renewable fuel standard mandates imply biodiesel price is driven by that of the primary input—soybean oil. • An encompassing framework compares effectiveness of both futures contracts and a composite hedge combining them. • Results favor a composite hedge with greater weight often placed on soybean oil than on heating oil futures contracts.