What is Oil Hedging?

While the recent rally in oil prices has been a windfall for US producers, not all companies are laughing their way to the bank. Experts warn companies that hedged future production at prices below current levels could face losses of roughly US$7 billion if West Texas Intermediate (WTI) prices stabilise at US$68 a barrel in 2018.

So what exactly is hedging? Employed by crude oil producers across the globe, the practice sees buyers evade falling prices by locking in higher selling prices for future production. During the global downturn hedging spurred enormous gains for companies locking in future per-barrel sales at higher-than-market prices. This allowed them to secure future production profits and cushion themselves against the oil price slump. It worked a treat, with global research and consultancy group Wood Mackenzie estimating that between 2015 and 2017 the practice of hedging earned companies a huge US$23 billion.

Hedging turns sour for US producers

Now, the outlook isn't quite as sweet. Hedges capped bellow up-to-date market prices are translating to significant losses for some companies. In the wake of rising oil prices, American owned independent oil company Hess Corporation revealed that it had spent US$50 million unwinding existing hedges that capped WTI sales at US$65 barrel. Hess Corporation isn't the only entity losing upside exposure, with experts predicting that unwinding the hedges that once served as a lifeline will quickly emerge as a common trend for companies like Parsley Energy, Laredo Petroleum and WildHorse.

Producers cross fingers for low 2018 average

Of course, there is a chance that hedges may not be as much of a burden as experts predict. Not all analysts expect WTI prices to average US$68 a barrel or more in 2018. Instead, recent statistics from the US Energy Information Administration set the bar at US$65.58 a barrel. This could offer welcome relief for companies that have hedged production at lower prices.

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