Dan,
How does oil hedging work, if the oil company can not produce, if the pipeline company can not take the oil if the pipeline is full and the company does not have any storage capacity? Could this happen to Callon, or at least their production can be significantly reduced. Will their revenue be determined by the Hedge Price and the ACTUAL Production rate?
Question on Oil Price Hedging
Re: Question on Oil Price Hedging
All upstream companies sell their physical oil, gas and NGLs into the physical market, usually under contracts that they have with midstream companies. For example, Lonestar sells all of their produced oil to a gathering company under a contract tied to the Louisiana Light Sweet (LLS) oil price less transportation costs. LLS sells at a premium to WTI.
Settlement of hedges has NOTHING TO DO WITH PHYSICAL PRODUCTION.
Hedges are "paper" transactions that are basically just puts and calls on a commodity futures contract instead of on a stock. An upstream company doesn't have to have any production to buy & sell puts and calls on oil futures contract and neither to you or a fund that has zero production. Just like you don't need to own a stock to buy & sell puts and calls. < Upstream companies rarely hedge more than their physical production, but it does happen and it is not "illegal" to do so.
Basically this is how hedges are settled in cash: If an upstream company owns a Put on WTI oil at $50/bbl and the average price during the month for the NYMEX contract the Put is tied to was $30/bbl the counter-party to the Put has to pay the upstream company cash of $20/bbl.
So, the oil prices used in all of our forecast/valuation models are (Physical sales at market prices + estimated cash settlement on hedges) / forecast volumes. < "market prices" include regional price differentials.
Settlement of hedges has NOTHING TO DO WITH PHYSICAL PRODUCTION.
Hedges are "paper" transactions that are basically just puts and calls on a commodity futures contract instead of on a stock. An upstream company doesn't have to have any production to buy & sell puts and calls on oil futures contract and neither to you or a fund that has zero production. Just like you don't need to own a stock to buy & sell puts and calls. < Upstream companies rarely hedge more than their physical production, but it does happen and it is not "illegal" to do so.
Basically this is how hedges are settled in cash: If an upstream company owns a Put on WTI oil at $50/bbl and the average price during the month for the NYMEX contract the Put is tied to was $30/bbl the counter-party to the Put has to pay the upstream company cash of $20/bbl.
So, the oil prices used in all of our forecast/valuation models are (Physical sales at market prices + estimated cash settlement on hedges) / forecast volumes. < "market prices" include regional price differentials.
Dan Steffens
Energy Prospectus Group
Energy Prospectus Group