This post is the second in a series exploring common strategies which can be utilized by oil and gas producers to hedge their exposure to crude oil, natural gas and NGL prices. You can access the first post via the following link: The Fundamentals of Oil & Gas Hedging - Futures. In subsequent posts we'll explore how oil and gas producers can hedge with options and more complex strategies.
It should be noted that because Brent crude oil futures expire on the last business day of the second month proceeding the relevant contract month the January futures contract is the prompt futures contract during the March production month. As a result, a November swap will settle vs. the January futures contract. If the swap were a WTI swap rather than a Brent swap, the settlement would be calculated against the December WTI futures contract from November 1 – November 21 (the expiration date of the December futures contract) and the January futures contract from November 22 – 30.
In the first scenario, let's assume that average settlement price for the prompt Brent crude oil futures, for each business day in November is 58.78/BBL. In this case, the price you receive at the wellhead for your November crude oil production would be approximately $58.78/BBL. However, because you hedged with the $48.78 swap, you would incur a hedging loss of $10/BBL which equates to net revenue of $48.78/BBL. In this scenario, while you did experience a hedging loss of $10/BBL, the hedge did perform as anticipated and allowed you to lock in a price which was $3.78/BBL more than your budgeted price of $45/BBL.