Oil Gas Companies Hedging Analysis

After the declaration of the recession caused by global pandemic Covid-19, businesses worldwide have been affected majorly and the economies worldwide have slowed down. One of the severely affected sectors is Power & Energy. The Energy markets remain volatile, with fewer oil and gas producers in place than in previous years. Additionally, several producers hedge with strategies that include sales position large portions of their revenue. Essentially, this creates a trap door where a business does not have price control below the sale price. The U.S. oil price closed at $31.50 a barrel, well below the $50-per-barrel level that many companies had hedged. Oil and gas prices faced barbarian dynamics at the beginning of 2020. Initial OPEC supply moves and the increase in U.S. oil production have been overshadowed by an international oil demand crisis that has brought the world to a standstill. Natural gas faced oversupply and low prices by the beginning of 2020. More efficient heating, cooling and market demand somewhat balances the impact of lower demand from industry and exports on gas prices and the decline in US shale oil production.

Why Oil & Gas Companies opt for Hedge?

On Monday, April 20, 2020, U.S. crude oil prices traded below zero for the first time, meaning producers or traders were essentially paying buyers to take crude oil off their hands. WTI opened for trading on Monday, April 20, 2020, at $18/bbl. By the end of the trading day, it had dropped to as low as minus $40/bbl

E&P oil & gas companies are engaged in capital intensive activities and need much cash in hand. These companies have fairly clear goals to look for, produce, and extract hydrocarbons. Companies need sufficient cash flow, not only to sustain the level of financial expenditure and excavation activities to ensure the continuous flow of oil and gas but also to make loan repayments, to ensure compliance with debt agreements, and to facilitate administrative expenses. Hedging programs at upstream companies are developed with the primary purpose of providing a level of cash flow to increase the likelihood of meeting those needs.

Without the security of an efficient hedge plan, the cash flows of an upstream company are subject to market volatility. Upstream companies without hedges will benefit from higher oil prices, though they have a very limited time to respond when oil prices fall. This is a situation that most other upstream companies faced during the 2014 price slump and encountered at the beginning of March 2020. Using hedge instruments, producers are price-protected except if prices fall below a certain limit.

"We will never let the great U.S. oil & gas industry down. I have instructed the Secretary of Energy and Secretary of the Treasury to formulate a plan which will make funds available so that these very important companies and jobs will be secured long into the future!"  - President Donald Trump

Then there are those in the oil industry who do not want government interference. At a state energy regulator hearing in Texas to discuss oil production restrictions, executives after executives argued that the free market would be permitted to work, and low prices should take care of low prices. Although though U.S. oil futures markets turned negative for the first time on April 20, many major producers of shale oil and gas were shielded from low hedge rates in 2020 and many refinanced loans in recent years were put off due debt.

Fatpos Global predicts that the E&P Oil & Gas market is anticipated to register a significant CAGR in the coming years. Looking at the current scenario and prospects out of such circumstances, most companies are likely to adopt a strategy mix of swaps and collars. Primarily anticipated to be adopted by major key players, the hedging strategy will work in the short-run but in the long-run hedges are not promising. Over the next few months, hedging is likely to be in the game.