Crude Oil & Natural Gas HedgingA study of independent exploration and production companies in Australia, Canada and the United States.2Thisstudywasconductedtorevealthecurrentstate ofhedgingamongstsmalltomidsizeindependent crude oil and natural gas producers.41% of study partcipants regularly hedge their crude oilandnaturalgasproducton,while29%saidthey never hedge their producton.Only 13% of the partcipants are required to hedge by their lenders and/or investors.The majority of the partcipants which indicated that theyhedgeonaregularbasisstatedthat,onaver-age, they hedge 51-71% of their current PDP (proved, developed, producing) volumes.36%ofthepartcipantsstatedthattheirCEOorCFO makes their companys hedging decisions.Swapsandcollarsarethemostpopularhedgingin-struments utlized amongst study partcipants.Only 34% of the partcipants indicated that establish-ing stable and predictable cash fow is the most impor-tant goal of their hedging actvites.67%ofthestudypartcipantssaidthattheywould characterizethesuccessoftheircompanyscurrent and past hedging initatves as good or excellent. IntroductionThecrudeoilandnaturalgasmarketshaveexperi-encedsignifcantchangesduringthepasttwoyears. Betweencrudeoilmovingfrom$146to$33inless thanfvemonthsandnaturalgasgoingfromnearly $14 to $3 over the course of a year, the past eighteen months have been incredibly volatle to say the least. Addinginsulttoinjury,thestateofthecapitalmar-kets has lef many producers without access to much needed capital.Theprimaryfocusofenergyriskmanagementasit relates to crude oil and natural gas producers is hedg-ing. Consequently, this subject forms the basis of this study,whichstrivestoanalyzethecurrenthedging practcesandstrategiesofcrudeoilandnaturalgas producers. Overview66% of the study partcipants indicated that their com-pany is privately held.53%ofthepartcipantsindicatedthattheyoperate their assets, 13% stated that they are non-operators, whiletheremainderhavebothoperatedandnon-operated assets.Crude Oil & Natural Gas HedgingA study of independent exploration and production companies in Australia, Canada and the United States.Inthesetimesofsignicantchangeanduncer-tainty,itisessentialthatoilandgasproducers employsolidhedgingandmarketingstrategies. Thesestrategieswillnotonlyallowproducersto survivethemostchallengingtimes,butwillalso allow them to excel in the best of times as well.Crude Oil & Natural Gas Hedging337% indicated that they market their own producton, 26% have outsourced their marketng to a third-party marketer, while the remainder employ a combinaton of both internal and external marketng.Study partcipants indicated that their average month-ly natural gas producton is 512,000 MMbtu, average monthlycrudeoilproductonis79,000barrelsand average monthly NGL producton is 30,000 barrels.Partcipantsstatedthatthemajorityorasignifcant percentage of their assets are located in:Capital13%ofrespondentssaidtheyarerequiredtohedge bytheirlendersorinvestors.Theremainderarenot requiredtohedgeorarenotcurrentlyrequiredto hedge.Of those required to hedge, 23% are required to have hedgesextending13-24months,while15%arere-quiredtohavehedgesextending25-36months.The remainderarerequiredtohedgevaryingduratons based on market conditons.61%ofthepartcipantsindicatedtheydonotem-ployhedgeAccountng,while27%doemployhedge accountng.Theremainderindicatedthattheywere unaware if they employed hedge accountng.Regardingtheirexistngdebt,thestudypartcipants indicated the following:HedgingWhenaskedwhomakestheircompanyshedging decisions,aswellaswhatpercentageoftheirexist-ingproductoniscurrentlyhedged,thepartcipants responded as indicated in the charts shown below.CONCENTRATION OF ASSETSTexasLouisianaMid-ContinentRockiesAppalachiaNew MexicoOtherDEBT SNAPSHOTHighly LeveragedModerately LeveragedLow LeverageNo DebtHEDGING DECISION MAKERSManagement TeamBoard of DirectorsHedge CommitteeCEO or PresidentCFOPERCENTAGE OF PRODUCTION HEDGED% of Participants% of Current PDP HedgedCrude Oil & Natural Gas Hedging4Hedging Continued34% of the study partcipants indicated that stable and predicablecashfowisthemostimportantaspectof their hedging actvites, while 29% indicated that their primaryhedginggoalistomitgatetheimpactofa signifcant price decline. The remainder indicated that the most important characteristc of their hedging ac-tvites is to maximize their borrowing base and/or to generate profts via speculatve trades.Partcipants stated that they are currently and/or have previously utlized the various hedging instruments as indicated in the chart shown below.Hedging SuccessWhen asked how their company determines whether their hedging actvites are/have been successful:-45%statedthatestablishingstableandpredictable cash fows is their defniton of success.- 29% stated that their hedging actvites are success-ful when their hedging strategies improve the botom line.-10%statedthattheyviewsuccessfulhedgingasa means to obtaining additonal access to capital.Theremainderindicatedthattheydeemtheirhedg-ing actvites as successful when they are able to take advantageofabnormallyhighpricesorwhenthey experience an appreciaton in the companys stock in response to their hedging actvites.How To Improve HedgingWhen asked how they could most improve their com-panys hedging actvites:-42%saidutlizinghedgingstrategiesthatbeter refect the companys risk tolerance, goals and objec-tves.- 31% said their hedging would be most improved by optmizing their existng hedge positons.-23%saidbeterexecutonandimplementatonof hedging strategies.-4%saidtheirhedgingactviteswouldbemostim-proved if they were able to implement strategies that would allow the use of mark-to-market accountng.Hedging Data & InfoWhenpartcipantswereaskediftheircompanyre-ceives hedging and/or marketng advice, data or infor-maton:-26%indicatedthattheyreceivethisinformaton from their bank.-24% said they receive it from their marketng com-pany.-24%receiveitfromtheirhedging&riskmanage-ment advisor.-11%receivefromtheirfuturesbrokerorclearing frm.HEDGING INSTRUMENTS UTILIZED BY PARTICIPANTSSwapsFuturesPuts, Independent of CollarsFixed Price Forward ContractsVolumetric Production PaymentsCollarsCrude Oil & Natural Gas Hedging5- 13% said they do not receive any hedging or market-ing advice or informaton from third-partes.When asked what type of informaton they would like toreceiveasitrelatestohedgingandmarketng,we received the following responses, amongst numerous others:- Anexplanatonoftherolespeculatorsplayinset-tng prices on a daily basis.- Adviceonwhathedginginstrumentstoutlizein various market conditons.- Descriptons of the methods and benefts of hedging.- Comparisonofariskmanagementprogramversus specifc one-of hedge transactons.MethodologyThis report provides an overview of the current hedg-ing practces of small to midsize crude oil and natural gasproducers.Thethirty-eightpartcipantsofthe studywereinvitedtopartcipateviaemailandtele-phone.Thestudywasconductedonlineduringthe Summer and Fall of 2009.MercatusEnergyAdvisors,LLCisaHoustonbased energy trading & risk management advisory frm that provides crude oil and natural gas producers with so-lutons to mitgate exposure to volatle energy prices, improveenergymarketngdecisions,optmizeassets and maximize fnancial results.MercatusEnergyAdvisors,LLCprovidesclientswith anin-houseenergyhedging,riskmanagementand tradingteam,allowingthemtofocusontheircore business.MercatusEnergyAdvisorsistheleading,independent,energyriskmanagementadvisoryrm. 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