HEDGING PROGRAMMES
It is well known that a good hedge has
a thousand parents but a bad hedge is an orphan. Very few politicians have the necessary domain expertise and experience in hedging energy exposures but few will hesitate to become Monday-morning quarterbacks and criticize their political opponents hedging programmes if they can turn hedging losses into their own political gains.
Hedging & Speculation There is a general perception that speculation is bad and hedging is good. In reality, there is a fine line between hedging and speculation, and even ‘hedging experts’ often show considerable confusion and do not always agree even about basic principles. As a result, it is not reasonable to expect politicians to grasp and communicate the subtleties of a hedging programme to the various stakeholders. The degree of subjective decisions that
should be allowed in a hedging strategy such as the ability to time the market entry or exit based on market views is often a controversial topic. Therefore, programmes with a large subjective element or those expected to make money on a consistent basis are speculative by nature. Chesapeake, the second largest natural gas
producer in the United States, has one of the most ‘aggressive’ hedging programmes in the world. The company routinely adds the following quote in its investor presentations: “We don’t hedge just to say we’re hedged, we hedge to make money.” It turns out that Chesapeake has successfully done so 24 of the 26 quarters as realized cash hedging gains since January 1, 2006 have been $8.7 billion.
Alternative Sovereign Hedging Programmes: Mexico & Norway
Mexico and Norway are two examples of countries
with active hedging programmes. Mexico produces close to 3 million barrels a
day which represent about one third of overall government revenues. Mexico has had a comprehensive oil hedging programme in place since the early 1990s as a part of the country’s economic policy. In the last few years, the programme has largely consisted of buying out of the money put options. Oil traders refer to this programme as the ‘Mexican Hedge’. Some of Mexico’s counterparties include Goldman Sachs, Barclays, JPMorgan, Barclays Capital and Deutsche Bank. Due to its large size, it is not surprising that
Mexico’s hedging programme has made headlines over the years:
Since its inception, Mexico has enjoyed most
of the upside from increased prices while having a floor on production revenues to ensure that unexpected budget shortfalls would not cause large macroeconomic shocks. An alternative to hedging with financial
instruments is to create ‘stabilization funds’ made from surplus oil revenues. Stabilization funds can be used when energy and commodity prices decline. Norway’s is probably the most successful case
of a long term stabilization fund. Norway found large oil reserves in the late 1960s. To reduce the impact of oil price volatility and also to take into account declining production volumes over time, the country created a fund where the surplus oil revenues are deposited.
December 2012 87
Reasons For & Against Hedging by Sovereigns
Reasons For Hedging
Reasons Against Hedging
• 1991 – hedge with put options at $17 per barrel; $800m profits.
• 2008 – Mexico hedges with out of the money puts at a range between $70 to $100 per barrel.
The strategy resulted in profits over $3bn when prices collapsed.
• 2011 – Mexico purchases puts to guarantee floor above $85 per barrel for 2012. Prices settle above
the floor levels, which means that the options expire unexercised.
• 2012 – Mexico changes strategy to include put spread to reduce costs. The strike of the puts
bought is around $80 to $85 per barrel while the sold puts is $60 per barrel. Mexico does not have protection if oil prices fall below $60 per barrel.
Lower Borrowing Costs Improved Credit Rating Revenue Predictability
Lower Macro Uncertainty
Lack of Hedging Experience & Skills
Up-Front Payments & Margin Costs
Political Ramifications & Negative Media
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