Hedging Policy in Oil Sector: Empirical Analysis

There is a significant variation of proportion of production hedged among oil and gas companies that is not completely explained by existing literature. The paper addresses the issue and studies the determinants of commodity hedging policy of oil and gas companies. Using the unique data set with quarterly data on hedging decisions of 139 companies in USA and Canada that produce oil, gas and gas liquids we examine whether wider spread between the forward commodity price and historical average price and higher average costs of sales are associated with higher proportion of production hedged. The empirical evidence shows that spread between forward and historical average commodity price and average costs are positively associated with proportion of production hedged, but the effect of the factors is not substantial to explain the significant existing variation of proportion of production hedged. Such results can be explained by the existence of factors that accounts for individual characteristics and which arenot included in the model. We suppose that such factors can reflect the shareholders’ attitude towards risk which governs the target hedging level. Another explanation is connected with debt covenants that can be established for the company. Although net debt/EBIDA variable is not significant, it can be the case that the company gets the covenant when it attracts the sizable debt, and the covenant is not influenced by further increase of debt level.