Once again it's time for our monthly energy hedging Q&A.  If you would like to pose a question for one of our future Q&A posts feel free to contacts us or leave a comment below.

In a perfect world, you would have a "long term" fuel hedging initiative in place (which includes a well developed hedge/risk management policy that addresses what can or should be done in extremely volatile price environments) which would mitigate your exposure to the extremely volatile days like we've experience this week.  If you don't have a risk management policy in place, it's time to develop one.

That being said, if you determine that you need to be initiating new fuel hedges in a volatile, fast, bull market, it's probably best, at least in near term, to stick to conservative hedging strategies such as buying call options or perhaps call option spreads, as the market could very well sell off given how fast and strong it's been over the past week. 

How can we (crude oil producer) sell a one year swap at the current market price while limiting our exposure to potential cash flow and/or margin call issues if prices move significantly higher as was the case in 2008?

The simple solution is to obtain a line of credit with a bank that understands your business, understands the potential cash flow implications of a producer being short a swap in a rising price environment and has the ability and willingness to "support" you and your hedge(s) should prices remain "high" for an extended period of time.

If the above isn't possible, another alternative would be to sell the swap as usual and then buy an out of the money call option as "disaster insurance" against crude oil prices continuing to move higher from here.  As an example, let's assume you sell a $100 crude oil swap for March '11 - February '12.  You could then purchase a $125 call option for the same tenor which would mitigate your risk, including your cash flow risk, if crude trades above $125/BBL.  As an aside, during the run up in 2008, we're aware of at least a few oil and gas lenders who purchased out-of-the-money call options to hedge their internal cash flow risk  to customers with crude oil swaps or call options that were "under water" at the time.

If you'd like to discuss how we can assist you with fuel or crude oil hedging or anything related, please don't hesitate to contact us.