US independent oil and gas companies have responded to the recent spikes and increased volatility in oil and natural gas prices by stepping up the practice of price hedging to shore up earnings and capital spending.
Hedging can be a tricky practice to manage, and guessing wrong on price can do a lot of damage to a company's bottom line. The depth of the recent plunge in US gas prices caught virtually everyone by surprise, so some producers have succeeded nicely with what historically might have seemed high-priced hedges. Others missed a golden opportunity.
But, in general, US independents are becoming more comfortable with the practice. While taking a breather from the wild price rollercoaster natural gas prices have been on of late, independents are devising new hedging strategies for coping with the vagaries of ever-more volatile commodity prices.
Increased hedging
US independents have watched natural gas prices drop from around $10/Mcf in December to about $3/Mcf in recent weeks. Oil prices also have fluctuated, as the world watches the Organization of Petroleum Countries work to maintain its targeted oil price band.
Hedging is one strategy that independents use to try to lock in oil and gas prices as they strive for predictable cash flows to support exploration and development spending plans.
"Companies have been doing more hedging on gas recently than they have done historically," said Robert Morris of Salomon Smith Barney. "Companies took advantage of high gas prices for two reasons: One, they anticipated that prices would fall. Two, they wanted to protect their spending."
But with gas prices falling substantially, companies have grown more reluctant to hedge. Morris said he believes companies probably have finished most of the hedging planned for the rest of this year going into early next year.
Hedging involves using a variety of financial instruments such as futures contracts and options. The idea is to manage risk and ensure more predictable cash flow, although any company using hedging is apt to be questioned-and sometimes criticized-about the practice by some investors and analysts.