OIL PRICE RISK MANAGEMENT IN THE 1990s—ISSUES FOR PRODUCERS AND LENDERS

Abstract

Oil prices have exhibited considerable volatility over the past five or ten years and the management of oil price risk has become an important factor in underpinning the viability of many oil producing operations from both a lender's and investor's perspective. Various oil based hedging products are now available to protect against such volatility, ranging from products which fix forward prices to option based arrangements which set a floor price but retain some (or all) of the potential upside. These products have particular relevance for petroleum companies with limited financial resources or who are looking to limit recourse to particular assets/cashflows.

There are a number of techniques which can be successfully combined to mitigate oil price volatility and the most relevant of these to a producer are discussed. The recent development of the Tapis swap and option markets, which have provided flexibility to Australasian producers, is also discussed.

Oil based financial products can also be used as a method of funding (say for a development or acquisition) as an alternative to traditional cash based borrowing structures, thus creating a natural hedge against oil price movements. The use of such structures, coupled with a well structured revenue hedging program, can enhance a project's attractiveness from a lender's perspective (particularly with respect to protection against downside movements in oil price) and/or provide greater certainty of returns to producers.

A case study of a recent commodity risk management based financing is presented which highlights many of the points discussed.