Hedge Strategy Development

ERC staff members have developed hedge strategies for a wide variety of entities in the energy industry. These hedge strategies have involved both the consumption and production of natural gas, crude oil, petroleum products, and energy conversion margins (i.e., for refineries and power plants). ERC’s hedge strategy development takes into account the unique risk tolerances and operating constraints of its clients, and ERC is well versed in meeting clients’ conflicting requirements of achieving efficient risk reduction while minimizing hedging costs.

Strategy Drivers

ERC has extensive experience in working with clients to develop hedge strategies based on several criteria:

The degree of hedging required to meet risk reduction objectives
Active versus passively managed risk management programs
Liquidity considerations
The relative efficiency of various hedging instruments
Sensitivity to mark to market losses
Determining the appropriate circumstances for price insurance hedging approaches versus fixed-price approaches
Determining symmetrical versus asymmetrical risk reduction objectives (e.g., lock-in prices vs. avoid price spikes) and appropriate strategies
Collateral funding requirements
The implications of a client’s creditworthiness and that of their counterparties

Instrument Selection

Market instruments and specific risks have varied across the programs developed by ERC. Some clients have wanted to avoid exchange-traded products because of the high capital cost of collateral (exchange margin) while taking advantage of reduced borrowing costs (municipalities) or large credit lines for over-the-counter trading with investment banks. Others have preferred to use exchange-traded instruments because of their small transaction size, liquidity, and anonymity. Some have preferred fixed-price instruments that lock in specific values, while others have preferred to pursue a price insurance approach (e.g., the application of call and put options, and call-like and put-like structures) to achieve a specific amount of risk reduction while leaving open the potential for future cost savings or additional revenue. For those that prefer a price insurance approach but who are put off by the high cost of option premiums in energy markets, ERC works with its clients to apply creative strategies to reduce the upfront cost of price insurance.

ERC has worked with many clients to resolve conflicts between risk management objectives and the perceived results of hedging programs, and to revise hedging strategies after realizing that hedging programs are not producing the desired results.