Harvard Ponders Energy Futures

To brace against rising oil costs, University may add futures holdings

While Harvard’s endowment managers often speculate on oil prices, other arms of the University may soon enter the complex world of energy futures trading.

The University’s potential move would be a “cutting-edge and intriguing” means of safeguarding against rising oil costs, according to Emanuel Balarie, a senior market strategist at Wisdom Financial and a frequent media commentator on commodities and futures markets.

Energy costs have become a matter of financial concern for the University, according to Harvard’s Annual Report for 2005.

“Utility costs grew 10% due to higher market rates,” the report said. “The University is actively identifying and implementing strategies to mitigate the effects of volatility in the energy markets.”

And one such strategy—which Harvard’s financial planners have now put on the table—would be to sign long-term contracts that lock the University into a set rate for energy purchases.

This strategy would be different from any energy futures trading executed by Harvard Management Company (HMC), which handles the University’s endowment.

“These are business operations decisions, not investments (which are HMC’s responsibility),” Vice President for Finance Ann E. Berman wrote in an e-mail.

A futures contract is an agreement to buy a given quantity of a commodity—such as oil—at a given price on a set date.

If oil falls below the pre-agreed price, Harvard could end up paying more under the futures contract than it would otherwise. But if oil prices rise—as University officials worry they might—the futures contracts could save Harvard huge sums.

An investment firm such as HMC might buy energy futures so that it can make a profit if the cost of oil rises above the contract’s pre-set price. By contrast, the rest of the University has no choice but to buy oil. Its incentive for entering the futures market is to shield itself from a budget crunch in the event that energy prices soar.

Even though HMC has a different motive for its energy trades, Berman wrote that HMC might play an advisory role in the execution of any futures hedging by the rest of the University.

“Decisions regarding the use of financial tools such as energy futures would be undertaken by the central administration with advice from HMC,” wrote Berman.

“The initiative comes from the group within University Operations that purchases energy for the university,” Berman wrote.

University President Lawrence H. Summers has also encouraged Harvard officials to consider futures hedging.

In an interview with The Crimson earlier this month, Summers said that he felt the possibility of trading energy futures should be explored.

Summers said, “I just raised the question of: is it a good idea for the University to think about hedging to avoid risk and the financial people are working on it?” Summers said.

But, Summers added, “I don’t follow what they decide.”

Summers also said that, “at a moment of volatility in energy prices, the idea that you should think about hedging against fluctuations in energy prices is sort of an obvious idea. Whether what they will decide is ultimately in the economic interest of the University, I don’t know.”

Balarie, the financial strategist, said that Harvard “has been at the forefront” in the commodities markets—pointing to past work by the University’s endowment managers.

But it’s not alone in exploring futures hedging plans.

According to Berman, this idea is being considered at Harvard’s peer institutions.

“I know from messages from my peers at other institutions that just about everyone is thinking about it now,” Berman wrote.

However, Mark A. Taborsky, a managing director at Stanford Management Company—the arm responsible for managing Stanford University’s endowment—said that, while he sees energy futures trading as a promising avenue for hedging against future volatility in energy markets, it is not something currently being considered by Stanford.

“The climate is a lot warmer in California, and we do manage our endowment to take account of all the inflation that occurs in running an educational institution,” says Taborsky. “We take into account energy costs, but we don’t directly hedge.”

Taborsky says that current oil prices make a hedging decision difficult.

“It’s a lot easier to make that decision when they are at historic lows, but they are at historical highs,” Taborsky said.

“Am I comfortable locking in, or is a $60 barrel a high?” Taborsky asked.

Harvard could be months away from making its final decision on whether to trade energy futures, according to Berman.

Light sweet crude oil prices topped $68 a barrel last month but have since fallen under $62.

—Staff writer Alexander H. Greeley can be reached at agreeley@fas.harvard.edu.

—Staff writer Cyrus M. Mossavar-Rahmani can be reached at crahmani@fas.harvard.edu.