26 Feb Ditching the Hedging

It is difficult to say how well hedged or otherwise was the oil industry as we headed into this low price cycle. The first quarter’s results will prove informative. But some companies who planned to hedge found they could not do so because the trusted counterparties with whom they had signed International Swaps and Derivative Association (ISDA) contracts were no longer in the market to quote on hedge packages: US Dodd Frank regulation has caused them to shut up shop and move out of the business.

Alternative counterparties exist: the major oil companies and the trading houses have always been competitors to the US banks who used to be the “go to” people for hedging instruments. The Swiss and other non-European banks are also moving into the space but in many cases without the physical oil trading capability that sharpened up the derivative quotes that used to be provided by US banks.

With the current level of regulatory paranoia no company is going to offer a hedge instrument without having an ISDA in place and formal board mandates from their customers confirming high level authorisation of the hedging action of the traders on the desks of the small oil and refining companies. By the time the small producing companies had sorted out this paperwork the boat had sailed on hedge prices that supported the base case price assumption for 2015 budgets.

Consumers would be well advised to learn from this lesson and start getting paperwork and mandates in place now if their intention is to hedge against an oil price rise in the foreseeable future.