Your company has just received an IDIQ requirements contract from the United States government to purchase a minimum of fifty million barrels of crude oil at $55 a barrel. The projected schedule calls for the delivery of 5 million barrels a month for the duration of the contract, two years plus three one-year unilateral government options. You received your first order for 5 million barrels today. You are currently producing 5 million barrels a day at your Texas properties and have plans to open additional wells over the next six months to increase output to 6-7 million barrels a day. The cost to deliver a barrel of oil today FOB Gulfport, Louisiana is about $35 a barrel.

Russia, OPEC, Iraq, and Iran just announced an agreement to manipulate the output of oil in order to increase its price above $60 a barrel. As such, the price of oil should increase, and the cost may increase as well.

Now the bad news, one of your offshore oil platforms off the coast of Mexico in international waters was attacked and captured by terrorists. Your oil workers were able to stop pumping oil and escape by helicopter. Tankers cannot dock or take oil for fear their ship will be taken by the terrorists. As a result, you are losing 2 million barrels a month and your contract with the government does not contain an escape clause that covers terrorists. What to do! To avoid a breach of contract situation you were able to find another source of crude oil to purchase at $55 a barrel, FOB Saudi Arabia for up to 3 million barrels a month and a maximum of 10 million barrels in total. You are also in contact with a company who, for $5 million dollars, will send in a team of Mexican drug cartel mercenaries to take back your oil platform. You expect it may take up to six months to regain control from the terrorists and return the platform to full operation.

Question:

How can you protect yourself from a rise in the price of crude oil; and

Determine your maximum and minimum loss exposure.