Do You Need Hedging?
Is This Your Predicament?
Are you an E&P company with significant natural gas production? Are you, however, frustrated by the prolonged slump in the price points that you are receiving? Are you at the mercy of the formula employed by your pipeline gatherers and those prices are based on spot prices at the Henry Hub (or a similar index)? Thus, your revenues are averaging around $3.50/Mcf this year?
But I'll bet you are also very aware of the futures prices for NG which are averaging better than $6/Mcf for 2010 and even higher the following year?
You are also probably aware that throughout this year that the price of each month's future contract deteriorates as it gets closer and closer to being the front[1] month? Do you remember that as of 12/31/08, if you looked out 6 or 9 months, you saw July NYMEX prices as $6.03 per Mcf? But, then, when July actually expired, the price had deteriorated by $2.08 to finish under $4. This decay has persisted all year! For example, October turned out worse. It went from $6.30 (in January) to close at $3.73.
Do you need those higher prices that are in that contango[2] curve? Can you afford to endure another year of this deterioration? The most important question is: Do you need to be defensive in your management of your NG production?
Oil is a different story altogether! There are attractive opportunities to hedge with it, as well. They are somewhat different since its fundamentals are not weak like that of NG and since its curve is not in a steep contango shape. Certainly, a motivated party can easily extract low-risk revenues in the $70s - even the $80s! - for 2010 which will nicely exceed a commercial lender's price deck applied to that production!
Problem
"I've know about the higher prices in the futures market for natural gas and I would like to take advantage of it, but my friend got skinned alive trying the same thing years ago." Is that the way you feel? Is hedging a mysterious "black box" with frightening pitfalls? Does the possibility of a "margin call" scare you? Is your financial staff either too over-worked or inexperienced to be able to take on a project far removed from your customary activities? If these questions resonate with you, then read on.
The Mission
For many E&P companies, suffering from low prices paid by pipeline gatherers, the contango curve necessitates a hedge.
Answer: Install an easy-to-use hedging program in my company.
Don't forget about oil! The reasons to hedge it are likely to be different, but there are numerous benefits to be reaped from installing a costless collar, for example.
[1] "Front" means the upcoming contract that is next to expire.
[2] Upward sloping futures prices; in other words, the prices paid for deliveries further out are higher and higher than the short-term expiring contracts. "Backwardation" is the opposite; that shape was evident in Summer 2008.