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Should Producers Hedge Natural Gas Now?

November 7, 2013

R^2,

 

Given the recent downward pressure on gas in 14, what could we do to protect cash flow but not limit future upside?

 

Sincerely,

Upstream Producer

 

Comments:

 

This is not a place we want to hedge if you don’t have to. The market has been in a tailspin for 2 weeks. The Cal 14 swap is at new lows and near its minus 2 STDEV bar. We would expect that any threat of cold weather should provide some lift to prices. This week we probed lower and then bounced with some force. We’d like to see if can’t rally further.

 

If your company can take the risk, we would prefer to wait for a better opportunity to hedge. In August, the Cal 14 swap rallied $0.45 after making new lows. Its doubtful that spot prices will fall below $3.25 in the next few weeks. Therefore we estimate that there is $0.25 of risk and $0.45 of potential reward if we delay the decision to hedge.

 

 

If hedging is required, then we prefer the following strategies. Coal becomes competitive with gas near $3.25. Therefore we do not expect gas to spend much if any time below $3.

 

The following HHUB strategies buy limited protection by capping the downside payout to that level. On the other hand, we think $4 is achievable, so to the extent possible we would like to keep upside to that level.

 

  SWAP LONG PUT SHORT PUT SHORT CAP
1Q14 $3.58 $3.40 $3.00 $3.85
2 & 3Q14 $3.64 $3.50 $3.00 $4.00
4Q14 $3.77 $3.60 $3.00 $4.25

 

Using the 4Q14 to illustrate:


Above $4.25, you get $4.25, $.48 higher than current prices.
$3.60 to $4.25 the price floats, you would $0.17 of risk and $0.48 of upside
$3.00 to $3.60, you would get $3.60
Below $3.00, you get the floating price plus $0.60. At $2.80, you would get $3.40.




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