Hedging strategy
Introduction
Hedging is defined as the acquisition of two or more positions at the same time with the objective of offsetting the losses in the initial position using the gains acquired from the latter position. The usual hedging involves creating a position for one currency and then creating a reverse for the same position on the same currency. This form of hedging guards the trader from receiving a marginal call considering that the latter position will acquire benefit with the loss of the initial one and vice versa.
In the IStar Company, it is composed of a variable-rate of lending assets as well debt obligations. These assets and liabilities allow a natural hedging against variations in the interest rates. This has the impact of increasing the interest rates with the company acquiring more on the variable-rate lending assets and pays more on the variable-rate debt obligation. While on the other hand, with a decline in interest rates, IStar acquires less on the variable-rate lending assets and pays a smaller amount on its variable lending assets, IStar puts to use a derivative instrument to reduce the implication of the changing interest rates on its net earnings. IStar’s interest rates risk management strategy needs it to get involved into hedging processes when it is firm, reliant on sensitivity models which affect the varied interest rates instances could have major disastrous impact on its net interest earning.
The company does not apply derivative mechanisms for speculative reasons. The derivative mechanisms applied are basically as interest rate swaps and caps. The swaps have the ability to transform the variable-rate debt obligations to fixed-rate debt obligations or vice versa. The interest rate caps limits the maximum interest rate allocated on variable-rate debt obligations. The company intends to match-fund assets denominated in foreign currencies with the intention that the variation in the foreign exchange rates will have a small implication in the earnings.
The risk the company is faced with is the application of derivative mechanism is the risk that another party to a hedging plan could impact negatively on its obligation as well as the risk that the company will pay on some costs like transaction or breakage costs if hedging plan is ended by the Company. The company gets involved in hedging plans with other companies that are large, creditworthy financial centers.
Oil companies are involved in surroundings that impact on the price movement on the global market stage. Such companies are involved in hedging practices that do much to alleviate the risks it may face when exposed to the global scene. Hedging is necessary so as to limit the cost of capital, uphold and maintain the company’s objectives and make it possible for the management to estimate performance.
Both the public and private companies in the oil industry apply hedging strategy. For instance, the EnerVest Management Partners Ltd is involved controlling oil and gas for investors. The forms hedges through acquiring economics; EnerVest through acquisition has managed to acquire 28% composite net rate of return in the industry’s processes. The executive vice president of the company and the financial officer have termed hedging to be a conscious choice to meet the price certainty for certain production sizes related to the realization that prices increase or decrease. The company hedges for approximately one and half years depending on the management’s choice if they appear in the commodity cycle of price.
Another hedging strategy put in place by the oil and gas companies is the hedging accounting. The United States apply complicated techniques of accounting put in place by the Financial Accounting Standards Board. The hedge accounting is different from the financial mechanisms; keen methods are applied before it can be applied (PennWell, November, 2005). The company is required to take into consideration all of the derivatives, be it assets or liabilities on the financial statements so long as the current commodity prices high or low the whole hedging value. According to hedging accounting their failure may be attributed to many reasons and is not connected to whether money is made or not.
Oil companies like Forest Oil Corp. which have experienced ineffective hedging techniques, he accounting controls require them to acquire a $72 million pretax, no charge. The company reported a third quarter earnings.
Another hedging strategy put in place by the oil companies is the restructuring of the hedging contracts. Price of the whole process brings to light the significance of acquiring a near-term hedge position. A company in instance is the Plains Exploration & Production Co. which applied hedges to offset higher local lifting costs and to alleviate a poor differential which is what crude oil acquires to their price on the New York Exchange. The hedging processes were transformed to elevate future met cash flow and earnings.
Some companies apply hedging so as to meet a rate return while they intend to control the increasing service, exploration and operating costs. The Anadarko Petroleum Corp. put in place hedges techniques of operating costs as a measure to guard against increasing costs of deep water drilling.
Conclusion
Hedging is a mechanism that is applied to manage risk which applied financial mechanisms so as to uphold the value of the future production against a drop in the prices of oil and gas. The named companies and many others apply hedges when acquiring so as to uphold cash flows for interest and major payments. These strategies make the companies to acquire the type, length, quantity and price requirements of the hedging processes.
Bibliography
PennWell. (November, 2005). US oil and gas companies reevaluate hedge strategies. Oil & Gas Journal.
