The dramatic slide in oil prices over the past year or so has once again underscored the value—and perils—of hedging. Some companies and governments bet on a fall in the cost of crude and thereby obviated large losses. Others did not make out so well.
FOR BETTER OR WORSE
Hedging contracts purchased before the fall in the price of oil left some petroleum-dependent companies with losses. Delta Airlines hedged to protect against a rise in the price of fuel by giving up some of the gains from a drop in the price of oil. The strategy led to a $1.2 billion loss linked to mark-to-market adjustments on fuel hedges. The carrier’s management, however, believes the low cost of oil will offset the losses from hedging.
Conversely, US shale drillers reportedly bought a safety net of around $26 billion in hedges. The fair value of the contracts held by 57 US companies in the Bloomberg Intelligence North America Independent Explorers and Producers Index rose to $26 billion as of December 31. That’s five times the amount such contracts were worth at the end of September.
The Mexican government also bet the right way. Between September and October of 2014—when oil prices were still hovering around $80 per barrel—the government bought its hedge for this year, spending 40% more on the contracts than what it spent in 2013. But with those hedges, the government, led by president Enrique Peña Nieto, locked in a price of at least $76 per barrel.
With the price of oil currently hovering at around $55 per barrel, it’s unlikely that the Mexican government will be able to get a similar deal for next year. In anticipation, policymakers have already announced a set of spending cuts that will be likely be doubled in the budget for 2016.