Recent volatility in the oil and gas markets has educated investors and focused management teams – with cash flow generation now a primary focus for both. Management teams have streamlined operations to deal with price swings, resulting in cost structures that are lean and largely fixed. With few cost levers left to pull, securing revenue at defined levels is a “must do” for management teams.
A well-managed hedge program is the only proven way to secure revenue. And while many oil and gas producers “place hedges,” the top performers actively manage a hedge program that continuously progresses through seven key steps:
- Know the production profile. If it sounds obvious, it is. Oil and gas producers undoubtedly understand current and expected production from assets. Assembling these production profiles and the impacts from proposed drilling programs is the first step in calculating and securing oil and gas prices required to deliver targeted cash flow.
- Have a view on the market. There are always both bullish and bearish scenarios, especially with current supply/demand dynamics, geopolitical risks, weather deviations, capacity-impacting infrastructure projects, and evolving macroeconomic trends. Understanding these relationships is at the heart of sound hedge decisions.
- Model potential scenarios. Producers should run multiple cash flow scenarios – risking revenue projections at various confidence intervals to understand the range of potential outcomes. Scenarios may include drilling program adjustments, operational risks, well results, weather interruptions, access to transport, capital constraints, regulatory impacts, etc.
- Secure the revenue. Selecting the most probable scenario and the corresponding revenue to secure is the base of the ultimate hedge plan. To execute the plan, producers need to be confident in navigating the derivatives market, executing trades to receive optimal pricing (an area of particular opportunity) and daily interaction with the market.
- Execute in the back office. While trading often gets the headlines, managing counterparties, documenting trades, tracking settlements/valuation, issuing receivables/payables, and creating reports – all while maintaining compliance with lender/internal restrictions – requires a stellar back office with proper controls and audit capabilities.
- Be proactive when opportunities present themselves. While constantly adjusting hedge positions can be counter-productive, there are times throughout the year when changes in price and volatility can present meaningful opportunities to improve the existing hedge portfolio. Producers must be active in the daily markets to identify those opportunities.
- Communicate with stakeholders. Investors, lenders, boards and management teams all have distinct needs and requirements as it relates to securing revenue and overall cash flow management. Management teams must be set up to service those needs with the necessary reporting and documentation to avoid being caught flat-footed.
Assumed within these seven steps is the ability to easily access information about the markets and the hedge portfolio. Market fundamentals, hedge coverage gaps, structures, pricing, valuations, settlements, counterparties and a full view of all open hedges are all paramount to the decision-making process and should be readily available through technology.
While each oil and gas producer will approach management of its hedge portfolio differently, certain steps are fundamental to consistently securing revenue. Most management teams have certain steps covered but are concerned with the high costs of building out a complete program when considering traditional costs of research, traders, ETRM platforms, dashboards, and back office activities.
However, selecting a partner to perform one or more of the steps allows management teams to leverage broader investments in research, trading, back office and technology platforms – resulting in a well-managed hedge program at a small fraction of the traditional cost.
Line of sight to revenue projections gives management teams the ability to execute plans and investors the confidence in those management teams. It is little wonder the number of oil and gas producers hedging prices has continued to increase. Whether currently hedging prices or still considering it, oil and gas producers would be well-served to assess the opportunity to leverage a partner in all or part of the hedge program.
AEGIS Energy Risk is redefining the way oil and gas producers manage cash flow risk and can fill in the gaps in your hedge program – from research to strategy to trade execution to back office to technology.
Please contact Briana Mueller at firstname.lastname@example.org/aegis to schedule a discussion on the costs and benefits of building a well-managed hedge program internally or with a partner.