Over the past few years we've seen significant changes in the energy markets, even more so as it relates to crude oil & natural gas hedging and marketing. These changes, particularly the extreme price moves, combined with challenging credit conditions, have led many oil & gas producers to seek outside expertise. However, this expertise and objectivity can vary greatly; hence selecting the right outside party(s) often becomes a task in itself. Having said that, based on our discussions with numerous producers, it's clear that many producers aren't sure where to begin. For starters, let's briefly explore the various types of companies that provide producers with hedging and marketing advice, the services provided by each and how each group is compensated for their services.
Brokerage firms (OTC & Futures) - Primary business is matching up buyers and sellers (producers, marketers, end-users and speculators), acting solely as a middle man. Many brokers provide their customers with hedging and trading recommendations as providing this information is often what "drives" their business. Brokers are normally compensated via a commission, either per contact or per unit.
Consulting Firms - Primary business is to provide their clients with independent, unbiased hedging and marketing advice. Their services are often tailored to the specific needs of each client. Consultants are generally compensated via a monthly retainer fee based on the scope and depth of the services provided and the complexity of the client's business.
Marketing & Trading Companies - Primary business is buying physical crude oil and natural gas from producers and reselling to end-users, refiners or other traders and marketers. Many marketing and trading firms also offer their customers financial derivatives i.e. swaps and options. Marketers and traders are generally compensated by the profit margins they earn on the spread. In addition, some marketing companies also charge a per unit (BBL or MMbtu) fee.
Banks - Primary business (in addition to traditional banking) is marketing and trading financial derivatives. In addition, some banks (primarily the large, investment banks) are now also involved in the marketing and trading of physical crude oil and natural gas. Like marketing and trading companies, banks are also compensated via the profit margin on the bid/ask spread. Clearly, banks are also compensated via the interest and fees they earn for providing traditional banking products and services.
Assuming you are planning to utilize an outside party to provide you with hedging and marketing advice, how do you select one whose interests are aligned with yours? Begin by seeking out experts with extensive knowledge of the crude oil and natural gas markets as well as significant hedging and marketing experience. Obtaining recommendations from your peers as well as your accountants, attorneys and bankers can often be a good place to begin as well.
Strong growth in the demand for hedging, marketing and trading experts has stretched many firms thin. Ask the companies you're considering how often and for what length of time they can make themselves available to you, either in person or on the telephone, on a regular basis.
Finally, what incentives, if any, do they have to steer you towards a particular product or service? Identifying these potential conflicts of interest may not always be easy, but awareness of the practice while conducting your due diligence will generally allow you to determine the existence of such conflicts.
An objective hedging and marketing expert(s) is a priceless asset to most oil & gas producers. The company you select, be it a brokerage firm, consulting firm, marketing and trading company or bank, should not only have extensive experience in hedging and marketing, but should also have an incentive to do what is best for you and your company.
What are your thoughts? Is your hedging and marketing team sitting on your side of the table?