As energy risk management advisors, we're often called in to help clients "stop the bleeding" caused by flawed energy risk management methodologies, practices and strategies. While we could easily write a book on the most common mistakes we encounter in our work, the following is a list of the erros we have witnessed most often in recent months.
"We decided to stop hedging because we never made money on our hedges." Hedging is not and should not be consider a source of revenue. A well designed energy hedging program, should, depending on whether you are a consumer, marketer, producer, refiner or trader, provide one or more of the following benefits:
- Cash flow certainty
- Revenue certainty
- Cost certainty
- A forecastable profit margin(s)
- Insurance against decreasing prices
- Insurance against increasing prices
"We have to hedge but can not incur any hedging losses." The vast majority of energy hedging errors are the result of a poor or nonexistent energy hedigng policy and/or the lack of a sound hedging strategy(s). Most hedging mistakes can be avoided by taking the time and effort to create a solid hedging policy and develop and implement strategies that allow you to meet your hedging goals and objectives. If this means you have to avoid losses, then you should probably only be purchasing options.
"We don't know whether prices are going to increase or decrease this year." Hedging decisions shouldn't be made solely, or even primarily, based on your view of future prices. If it were so easy to predict energy prices we'd trading from the beach and counting our profits. On the contracy, many make the opposite mistake and base their hedging decisions on where their personal market forecasts, forecasts which are, more of than not, wrong.
"We do hedge, but not when we think prices are going to move in our favor." What happens if you don't hedge and prices move against you? Do you wait a little longer and hope for a reversal? What do you do if the trend continues to move against you? We've heard this from dozens of oil and gas producers over the past couple years and as you can imagine, many of them are still waiting for prices to increase so that they can execute hedges at their target price levels.
"We're going to wait and see what energy prices do over next few months." Again, what do you do if/when prices don't move in the direction that is not in your best interest? Do you continue to wait or do you "cry uncle" and mitigate your risk? This has been the excuse we have heard most often from consumers in recent months. Many are still waiting to see if prices will return to the lows witnessed in the early part of the year...
"Sometimes we hedge 100%, sometimes we don't hedge at all. It depends on our view of the market." What happens if your view is incorrect? What type of impact does an incorrect view on the market have on your cash flow and profit margins? Is your crystal ball really that accurate? If it is please give us a call, we will gladly pay you a handsome fee to license it from you.
"We hedge when we see good opportunities." What if it takes months or years for a good opportunity to present itself? What do you do if there is a significant price move in the "wrong" direction while you are waiting on that good opportunity? This is one of the other perspectives we have heard all too often from oil and gas producers over the past couple years.
"We only hedge when we have a strong view on the market." We often have a strong opinion about the market ourselves, but if your strong market view is incorrect, what do you have at the end of the day? Declining revenues? Declining cash flows? Declining profit margins. Increasing cost of goods sold?
"We are hedgers, not speculators." If this is indeed true, congratulations, you're in the minority. If not, it's probably a good time to review your hedging strategies and risk management policy and determine, if you are, in fact, comfortable with your (speculative) positions and the risks associated with your speculative positions.