Shale Oil Hedging Case Study

b) Shale oil is rapidly emerging as a substantial and comparatively low cost newly progressive resource in United States. The impending emergence of shale oil presents key strategic prospects and encounters for the oil and gas industry. It growths energy independence from many countries and yet at the same time reducing the stimulus of Organization of Petroleum Exporting Countries (OPEC). Derivatives markets have become increasingly important in the world of finance and investments. The objectives of hedging strategies using futures is to remove uncertainty on a price risk. Although hedging reduces the risk but it is not necessarily the case whereby the outcome with hedging will be better than the outcome without hedging. There are significant

In the event where there is a fall in the spot price, any financial gains from a hedging program may be seen as speculative returns. Typically there is no perfect hedging in reality as it is difficult to have three features of a futures contract matches with the asset to be hedge. When there is an imperfect hedge, the loss in the spot market may not be covered by the gain in the futures. The importance to realize that hedging using futures contracts can result in a decrease or an increase in profits relative to its position with no hedging. If the price of oil drop, the futures position leads to an offsetting gain. Similarly if the price of oil rise, the futures position leads to an offsetting loss. It is clear that hedger s a consumer as it purchases an asset in the future and wants to lock in the price. Typically, the purpose of the futures contracts was to hedge its exposure to the price of oil and not making a profit. According to a spokesman for Callon, Eric Williams commented that a swap would be better if foresight to know prices were going to dip the way it did. By using three-way collars which limits the downside protection by selling a further put option. The purpose of selling lower-priced put option was to limit further the overall hedging cost. However, commodity prices is no seen falling so far that these put options have come into the money. Therefore, eliminating any further protection as prices continued to fall. With other producers not backing down, the new dynamic in the oil market created by extra U.S. shale production has changed the market context for U.S. shale oil and gas producers. This has certainly weakened prices where any further downward movement could prompt significant restructuring of the financial arrangements of the sector.