Morgan Stanley’s Sherk stresses value of oil hedging
Options have become good way for E&P firms to raise capital, top banker says
Options have become good way for E&P firms to raise capital, top banker says
Oil-producer hedging programmes have been crucial in helping the US energy industry weather the steep downturn in crude prices and, in the present environment, options transactions have emerged as an important way for exploration and production (E&P) companies to raise capital, according to Peter Sherk, the global co-head of commodities at Morgan Stanley.
"The energy industry right now is struggling. It's in a much tougher spot than it had been and that many had anticipated," said Sherk, speaking at Energy Risk Summit USA on May 17. "In the E&P space, cheap, available capital is a thing of the past in many respects. There is a lot of distress in the debt markets as a result of what's happening with the energy crisis. Hedging has helped."
To illustrate his point, Sherk cited a study carried out by analysts on Morgan Stanley's commodities desk on hedging gains by a group of about 40 mid-sized E&P firms. If oil prices stay roughly where they are now for the rest of the year, hedging gains by the group will total $9 billion this year, he said.
The price of West Texas Intermediate (WTI) futures for June delivery settled at $48.31 per barrel (/bbl) on May 17. Despite a rally over the last three months, that price is still 48% less than the average price of WTI in 2014.
Sherk noted that hedging gains were even more impressive in the wake of the 2008 oil price crash, when front-month WTI futures plunged from record highs of $147/bbl in July that year to less than $35/bbl in December. In 2009, the same group of 40 mid-sized E&P firms in the Morgan Stanley study enjoyed an eye-popping $15 billion in collective hedging gains, said Sherk.
"I had to check that a couple of times because I was astonished that it could be that big of a number," said Sherk. "Prices had fallen so far and hedging had been pretty aggressive. It kept a lot of these companies afloat when they would have gone under were it not for the ability to still service their debt because they had that revenue."
In retrospect, he added, the hedges US oil producers put in place prior to the 2008 crash allowed the industry to begin developing the technology of hydraulic fracturing, or ‘fracking', and horizontal drilling, which began to enter widespread commercial use in 2009–10.
"By hedging forward aggressively, producers were able to borrow a lot of money, they had access to capital and then, when the energy market crashed, they had all of these hedges in place," Sherk said.
Amid the distress in the E&P sector today, he added, derivatives can play a different role: helping oil producers sell their upside to raise capital. Producers should consider the sale of call options as a way to raise capital without the dilutive effect of issuing more equity, Sherk said. Such an approach differs from the more common way in which E&P firms sell call options: the zero-cost collar, in which a firm sells call options to finance the purchase of put options, effectively sacrificing its upside to protect its downside.
"You should look at upside not as a source of funding to protect your downside entirely, but also as a way of generating capital," he said. "I think this is the time. When capital was cheap and readily available it made no sense, but the timing is different now. This is the way we adapt, and maybe this is the way the industry ought to be looking at market opportunities today."
Only users who have a paid subscription or are part of a corporate subscription are able to print or copy content.
To access these options, along with all other subscription benefits, please contact info@risk.net or view our subscription options here: http://subscriptions.risk.net/subscribe
You are currently unable to print this content. Please contact info@risk.net to find out more.
You are currently unable to copy this content. Please contact info@risk.net to find out more.
Copyright Infopro Digital Limited. All rights reserved.
You may share this content using our article tools. Printing this content is for the sole use of the Authorised User (named subscriber), as outlined in our terms and conditions - https://www.infopro-insight.com/terms-conditions/insight-subscriptions/
If you would like to purchase additional rights please email info@risk.net
Copyright Infopro Digital Limited. All rights reserved.
You may share this content using our article tools. Copying this content is for the sole use of the Authorised User (named subscriber), as outlined in our terms and conditions - https://www.infopro-insight.com/terms-conditions/insight-subscriptions/
If you would like to purchase additional rights please email info@risk.net
More on Energy
Chartis Energy50
The latest iteration of Chartis’ Energy50 ranking
Energy trade surveillance solutions 2023: market and vendor landscape
The market for energy trading surveillance solutions, though small, is expanding as specialist vendors emerge, catering to diverse geographies and market specifics. These vendors, which originate from various sectors, contribute further to the market’s…
Achieving net zero with carbon offsets: best practices and what to avoid
A survey by Risk.net and ION Commodities found that firms are wary of using carbon offsets in their net-zero strategies. While this is understandable, given the reputational risk of many offset projects, it is likely to be extremely difficult and more…
Chartis Energy50 2023
The latest iteration of Chartis' Energy50 2023 ranking and report considers the key issues in today’s energy space, and assesses the vendors operating within it
ION Commodities: spotlight on risk management trends
Energy Risk Software Rankings and awards winner’s interview: ION Commodities
Lacima’s models stand the test of major risk events
Lacima’s consistent approach between trading and risk has allowed it to dominate the enterprise risk software analytics and metrics categories for nearly a decade
2021 brings big changes to the carbon market landscape
ZE PowerGroup Inc. explores how newly launched emissions trading systems, recently established task forces, upcoming initiatives and the new US President, Joe Biden, and his administration can further the drive towards tackling the climate crisis
How energy firms can keep up with the pace of digital change
In this webinar, a panel discusses what organisations should keep in mind as they embark on their digitalisation journey, the challenges of which they need to be aware to be aware and what is next on the horizon
Most read
- Quants are using language models to map what causes what
- Reluctantly, CME moves to clear US Treasuries
- The bank quant who wants to stop gen AI hallucinating