OIL HEDGING -WHO DOES WHAT

OIL HEDGING -WHO DOES WHAT

 Both oil consumers and producers can hedge price exposure, typically one to two years out.

 Different financial instruments can be used to hedge price exposure including futures, swaps and options. Impact on the price of oil in futures markets is variable. Options are a preferred means to hedge for a host of reasons, including mark-to-market or credit conditions.

 Stylised facts: Oil producers tend to use WTI to hedge their energy price risk. Oil consumers use Brent. However, combinations can be commonly found whereby producers use formulas to hedge (Mexico) that can involve a combination of crude oils and products.

 Cost of hedging when using options typically shows that downside protection is more expensive than upside protection (relative option pricing shows a ‘skew’). One reason is that consumers are not subject to the financing constraints that producers face – less pressure to hedge. As such, demand for downside risk protection is greater that for upside protection. 

Producers also sell calls options to finance put option purchases.

 Banks (and others) that offer hedging solutions to oil consumers and producers in turn hedge these transactions, warehouse the risk, or do a combination of both. What hedge providers decide to do may impact the price of oil in the futures market.