Energy Hedging
“The Basics and Beyond”
Sustaining Oklahoma Natural
Resources
www.devocapital.com
1
Futures Disclosure Statement
This material has been prepared by a sales or trading employee or agent of DEVO Capital Management and is, or
is in the nature of, a solicitation. This material is not a research report prepared by DEVO Capital Management’s
Research Department. By accepting this communication, you agree that you are an experienced user of the futures
markets, capable of making independent trading decisions, and agree that you are not, and will not, rely solely on this
communication in making trading decisions. DISTRIBUTION IN SOME JURISDICTIONS MAY BE PROHIBITED OR
RESTRICTED BY LAW. PERSONS IN POSSESSION OF THIS COMMUNICATION INDIRECTLY SHOULD
INFORM THEMSELVES ABOUT AND OBSERVE ANY SUCH PROHIBITION OR RESTRICTIONS. TO THE
EXTENT THAT YOU HAVE RECEIVED THIS COMMUNICATION INDIRECTLY AND SOLICITATIONS ARE
PROHIBITED IN YOUR JURISDICTION WITHOUT REGISTRATION, THE MARKET COMMENTARY IN THIS
COMMUNICATION SHOULD NOT BE CONSIDERED A SOLICITATION. The risk of loss in trading futures and/or
options is substantial and each investor and/or trader must consider whether this is a suitable investment. Past
performance, whether actual or indicated by simulated historical tests of strategies, is not indicative of future results.
Trading advice is based on information taken from trades and statistical services and other sources that DEVO Capital
Management believes are reliable. We do not guarantee that such information is accurate or complete and it should not be
relied upon as such. Trading advice reflects our good faith judgment at a specific time and is subject to change without
notice. There is no guarantee that the advice we give will result in profitable trades.
Commissions have not been included in the examples. Commissions must be taken into consideration to reflect
accurate profit and loss. Commissions can vary depending upon the Futures Commission Merchant and the
broker you work with.
www.devocapital.com
2
Who We Are
www.devocapital.com
3
DEVO helps their clients implement tailor made hedge programs based upon each
company’s specific hedging goals and needs.
________________________________________________________________________
________________________________________________________________________
DEVO Capital –NYMEX Traded Accounts
 Worlds largest commodity exchange
 NYMEX provides markets for all of the major energy markets, along with
many others
 On-line trading and transparency
All market participants on the New York Mercantile Exchange must have a
margin account
Advantages of NYMEX Traded Accounts
•Low credit or counter party risk
•Easy Access
Disadvantages of NYMEX Traded Accounts
•Margin: Requires you to post a deposit to guarantee the trade.
•Requires you to learn new marketing skills. It takes time to understand how the
markets work.
www.devocapital.com
4
DEVO is a registered Introducing Broker (IB) that offers trade execution and clearing at
all of the major world futures exchanges.
_______________________________________________________________________
_______________________________________________________________________
DEVO Capital – Over-the-Counter Trading
 Normally financed by the counterparties
 Need to set up ISDAs with counterparties
Must provide financials and reserve report
Counterparties review financials and establish a credit limit
Advantages of OTC
•No initial margin requirement
•Access to markets that are not NYMEX
traded
•Custom tailored to the individual parties
involved
Disadvantages of OTC
•Transaction cost built into execution price
•Difficult and expensive to adjust your
position
Counterpary
A
Best
Price
DEVO
Network
Counterparty
B
Counterparty
C
www.devocapital.com
5
DEVO breaks down the indications from the counterparties and works to make the
hedging process transparent by disclosing the broker’s cost, counterparty’s transaction
fees, the bid/ask, etc.
________________________________________________________________________
DEVO Capital –Agency
•DEVO works on an agency basis for producers to assist with
trade execution and hedge recommendations.
• DEVO has agency agreements with several major US banks
and numerous counter parties.
•DEVO brings transparency to the hedging process
•DEVO assists with market timing
www.devocapital.com
6
DEVO works on behalf of the producer. We receive numerous quotes from several credit
facilities and find the optimal hedge counterparty.
________________________________________________________________________
DEVO Capital –Consulting and Research
•DEVO consultants use their combined 80 years of trading and brokerage experience to help their
clients with any situation that they may encounter.
•DEVO analyzes the risk tolerance and develops a strategy in conjunction with the goals of their
clients.
•DEVO will educate individuals or large groups on the basics of futures, options, and swaps
•As the market environment and the needs of the client change, DEVO is there to make the
adjustments necessary to help their client reach their financial goals.
•Customized hedge strategies
•Marked to Market valuations
•Energy Research
•Weekly Energy Outlook, DOE/EIA Storage Numbers, Natural Gas Liquids Newsletter, Daily
Energy Weather Service, Monthly Energy Report, Daily Speculative Report, Brent/LLS Weekly
Newsletter, Special Trade Reports
www.devocapital.com
7
DEVO is a registered Commodity Trading Advisor (CTA). Being a CTA allows DEVO
to provide its client with energy specific research and trade recommendations. Our
research is the lifeline between DEVO and our clients. Our reports summarize the market
moving news stories for the week, highlight key fundamental and technical events and
provide specific hedge and trade recommendations.
________________________________________________________________________
DEVO Capital – Producer/Consulting &
Agency Services
DEVO
a n a lyz e s
c lie n ts risk
D E V O d e v e lo p s
h ed g in g stra te g y b a se d
o n m ark et en v iro n m en t
(c o lla rs, flo o rs, fix e d )
D E V O sets u p
O T C re la tio n sh ip s
and E xchange
acco u nt
D E V O n eg o tia te s O v e r
th e C o u n te r (O T C )
tra d e w ith b e st p ric e d
c o u n te r p a rty
D E V O w o rks
w ith c lie n t a s
c lie n t n e e d s
change
D E V O m akes
a d ju stm e n ts a s m a rk et
e n v iro n m en t ch a n g e s
www.devocapital.com
D E V O e x e c u te s
e x c h an g e trad e
D E V O m o n ito rs
tra d e a n d m a rk e t
e n v iro n m e n t
8
As your company grows so will your hedging goals and needs. This diagram displays
how DEVO’s services evolve with the producers needs.
________________________________________________________________________
Summary of Topics
1) Crude Oil and Natural Gas Market Overview
• US and Oklahoma
2) Factors affecting price risk
3) How to protect against these risks
• Hedge Examples
4) Recommended strategies
www.devocapital.com
9
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
U.S. Petroleum Production & Demand
Est.
www.devocapital.com
10
Demand in the US has dropped off since the financial crisis in 2008/2009 and has
remained relatively flat over the past four years.
________________________________________________________________________
________________________________________________________________________
Oklahoma Crude Oil Production
Source: EIA
www.devocapital.com
11
After hitting a 20 year low in 2004, production in Oklahoma has increased 36%.
________________________________________________________________________
________________________________________________________________________
Mid-Continent Crude Oil Production Numbers
www.devocapital.com
12
The Bakken, Permian, Eagle Ford and Niobrara formations have accounted for 2.75
million barrels a day in new production since 2007.
________________________________________________________________________
________________________________________________________________________
Crude Oil Differentials
www.devocapital.com
13
The inability to build pipeline infrastructure as quickly as new production comes online
has put a tremendous amount of pressure on major crude oil pricing points and led to
significant disconnects from WTI.
________________________________________________________________________
________________________________________________________________________
Crude Oil Prices
www.devocapital.com
14
From 2011–2013 WTI Calendar Average, averaged $95.41 a barrel.
________________________________________________________________________
________________________________________________________________________
Crude Oil Outlook
• After the historic run up in 2008 and the historic sell off in 2009, crude oil has traded in a relatively
tight trading range over the past three years
• Neutral for prices
• Global oil demand is expected to grow 1.25% in 2014 paced by China and other emerging markets
• Positive for prices
• US Domestic production is projected to increase to 9.5 million barrels a day by the end of 2015
• Negative for prices
• Progress was made between world powers and Iran in regards to the nuclear program, however,
geopolitical tension remains a wildcard
• Neutral for prices
• Speculators are holding a near record long position in crude oil
• Negative for prices
• Will the Federal Reserve continue with their bond buying program?
• Unknown
www.devocapital.com
15
Without a major geopolitical event, it is hard to make a strong bullish argument for crude
oil.
________________________________________________________________________
________________________________________________________________________
U.S. Natural Gas Production & Demand
BCF per day
Source EIA
EST.
MMCF per day
Source EIA
www.devocapital.com
16
Since 2005 natural gas production in the United State has increased 40% while demand
has only increased 18%. Oklahoma production has increased 36% during the same time
frame.
________________________________________________________________________
________________________________________________________________________
Natural Gas Production by Region
www.devocapital.com
17
By the end of 2015, Marcellus production is expected to increase to 20 BCFD while the
rest of the U.S. is projected to produce only 50 BCFD.
________________________________________________________________________
________________________________________________________________________
Natural Gas Prices
www.devocapital.com
18
After falling below $2 in 2012, natural gas prices have rallied over 100%.
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
Natural Gas Outlook
• Natural Gas prices for the most part have been locked in a $1.00 trading range over the
past year
• Neutral for prices
• 30% of US electricity is generated by natural gas
• Positive for prices
• Speculators are holding a net short position
• Negative or positive for prices
• Natural Gas production is projected to outpace demand in 2014
• Negative for prices
• LNG export market
• Unknown
www.devocapital.com
19
Although storage levels are at a 5 year low, it is difficult to make a strong bullish case for
the natural gas market. If prices remain at their current levels, it becomes more attractive
for producers to pursue natural gas plays that were seen as uneconomical when prices
were at the $3 level.
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
Financial Hedging Strategies &
Examples
Financial Hedging & Energy Marketing
Sustaining Oklahoma Natural
Resources
www.devocapital.com
20
________________________________________________________________________
Futures Contract
An agreement to buy, or to sell, a specified amount of a commodity, for delivery
at a specified time in the future, but at a fixed price today.
• Standardized as to delivery time and contract size
• Available to anyone
• Exchange traded (NYMEX)
• Liquidated by offset
• Readily available prices and statistics
• Low credit risk
• Marked to market
www.devocapital.com
21
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
Contract Specifications – Crude Oil and Natural Gas
Crude Oil
• 1 Contract = 1,000 Barrels
• Location: Cushing, OK
• Minimum “tick”: $0.01 per barrel
• $0.01 = $10
Natural Gas
•1 Contract = 10,000 MMbtu
• Location: Henry Hub, LA
• Minimum “tick”: $0.001 per MMbtu
•
$0.001 = $10
www.devocapital.com
22
________________________________________________________________________
________________________________________________________________________
Financial Hedging Strategies
1. Fixed Price
Establishes a set price
2.
Collars/Puts & Calls
Establishes a minimum (floor) and maximum (ceiling) sales price
3.
Floors/Puts
Establishes a minimum sales price
4.
Combinations
By mixing and matching the various tools, we can construct a strategy to take
advantage of any market expectation
www.devocapital.com
23
Fixed Price - establishes a set price; easiest to understand
Collars - gives you a minimum selling price (floor) and a maximum selling price (ceiling)
Floors - gives you a minimum selling price; you have to pay the premium
DEVO can help structure the right strategy to meet the company’s goals
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
Market Outlook - Strategy to Execute
Collars
Floors
Fixed
Bullish Outlook
Neutral to
In some cases it could
be seen as negative
Negative outlook
Lock in selling
price
Negative outlook
Combinations
Selling Short Term Premium
Bear-Put spread
www.devocapital.com
24
DEVO helps the producer completely understand the strategy before a trade is executed
and we assist the producer in determining which strategy should work best for the
company’s goals.
Market Timing
NYMEX Crude Oil
Distribution
150.00
120.00
90.00
60.00
Accumulation
Accumulation
J-11
S-11
M-11
J-11
M-11
N-10
J-10
S-10
M-10
J-10
M-10
N-09
J-09
S-09
M-09
J-09
M-09
N-08
J-08
S-08
M-08
J-08
M-08
N-07
J-07
S-07
M-07
J-07
M-07
N-06
J-06
S-06
M-06
J-06
M-06
N-05
J-05
S-05
M-05
M-05
30.00
Date
www.devocapital.com
25
There are 4 main phases to markets (Accumulation, Run up, Distribution, Run down).
Based on the phase the market is trading in, DEVO and the client determine which
strategy will help the company reach their financial goals.
________________________________________________________________________
________________________________________________________________________
Financial “Paper” Hedge
• Entering into a separate financial contract to offset
the price risk of the physical commodity.
• The following examples will assume:
- No Basis risk
- No Commissions/Fees
www.devocapital.com
26
Basis is the difference between the cash market and the futures market. Although cash
and futures tend to move in the same direction, supply and demand differences in certain
parts of the country can affect the price relationship between NYMEX and the different
delivery points. Refer to DEVO Capital’s special reports on Crude Oil Basis and Natural
Gas Basis.
Fixed Price Using NYMEX Futures
A fixed price is established by selling a strip of futures
contracts to establish a fixed price
• Selling
contracts gives producers the obligation to
sell their production at a specified price.
• Fixed prices are typically used when producers
are bearish on prices and want to lock in their
revenue stream or when producers are in the
acquisition phase and need to lock in their revenue
stream
www.devocapital.com
27
Exchange traded futures contracts are best suited for companies that have adequate cash
reserves, available financing, and a staff (whether in house or contracted), to devote a
considerable amount of time in managing market positions. DEVO Capital can act as a
contracted staff member using our consulting and agency services.
________________________________________________________________________
Pros and Cons of Fixed Price
• Sell the futures contract
• Pros:
- Highest fixed sales price
- Small cost if the market stays unchanged
•Cons:
- Margin Requirement
- No up-side participation
- Greater basis risk
•Potential Follow Ups:
• Liquidate as they mature
• Set pre-determined liquidation levels
www.devocapital.com
28
Well used and understood; eliminates second guessing. No upside participation. Most
cost effective way of hedging in a sideways to down market. The strategy works well
when the market is in a carry charge market environment (back contracts trading at a
premium to the front contracts).
________________________________________________________________________
Fixed Price as of 01/14/2014
WTI Cal. Avg. Crude
January
2014
WTI Cal. Avg. Crude
February
2014
92.87
92.74
WTI Cal. Avg. Crude
March
2014
92.55
WTI Cal. Avg. Crude
April
2014
92.19
WTI Cal. Avg. Crude
May
2014
91.63
WTI Cal. Avg. Crude
June
2014
90.98
WTI Cal. Avg. Crude
July
2014
90.21
WTI Cal. Avg. Crude
August
2014
89.48
WTI Cal. Avg. Crude
September
2014
88.86
WTI Cal. Avg. Crude
October
2014
88.24
WTI Cal. Avg. Crude
November
2014
87.70
WTI Cal. Avg. Crude
December
2014
87.01
90.372
Average
1-Year Fixed Price
www.devocapital.com
29
________________________________________________________________________
________________________________________________________________________
February 2014 Production Hedge
XYZ Producer has 3,000 bbls per month of physical
crude oil production. His purchaser buys his crude oil
based off the monthly average of the NYMEX spot
month. He is paid the following month for the
production.
Today is January, 14th, 2014 and XYZ Producer would
like to hedge his February 2014 production using WTI
Calendar Average Crude Oil Contract.
www.devocapital.com
30
________________________________________________________________________
________________________________________________________________________
February 2014 Production Hedge
XYZ Producer opens a futures brokerage account with a
Series 3 registered broker (NYMEX Traded Account).
He deposits his Initial Margin in his account.
•Initial margin currently is $3,800 per contract
(1,000bbls contract size)
•Producer would deposit a minimum of $11,400
($3,800 * 3 Contracts)
www.devocapital.com
31
________________________________________________________________________
________________________________________________________________________
Margin
• Posting money to guarantee payment
• Initial ($3,800) vs. Maintenance Margin ($3,400)
Pitfalls of Margin
• Requires cash or t-bill deposit
• Timing of cash flows
• 12-month strip (you have to pay for all 12 months now)
Benefits of Posting Margin
• Usually can execute at better price levels
• Get the safeguards that are in place on NYMEX accounts
www.devocapital.com
32
________________________________________________________________________
________________________________________________________________________
Margin Example
Source: NYMEX
During February prices rise
NYMEX Crude Oil Continuous
160
140
On February 14th Market rallied up to $95.00
120
100
On 1/14 our we sold the Feb.14 @ $92.74
80
Beg Balance $11,400 (Initial Margin)
60
40
Short 3 Feb.14 @ $92.74 and is currently @
$95.00 ($2.26 loss X 3,000bbls)
20
0
Liquidation Value: $4,620 ($11,400-$6780)
Initial: $11,400 ($3,800 per contract)
Margin call of $6,780
Maintenance: $10,200 ($3,400 per contract)
www.devocapital.com
33
Initial Margin- Preliminary equity deposited to secure financial positions. The margin
limits are set by the exchange.
Maintenance Margin- The minimum amount of equity that must be maintained in a
margin account.
________________________________________________________________________
February 2014 Fixed Price Production Hedge
Source: NYMEX
NYMEX Crude Oil Continuous
160
140
January 14th, 2014
120
Producer sells 3 Contracts
(3000 bbls) of Feb.14
Crude Oil at $92.74.
Contract expiration is
February 28th, 2014.
100
80
60
40
20
0
www.devocapital.com
34
________________________________________________________________________
________________________________________________________________________
February 2014 Fixed Price Production Hedge
Prices drop
Source: NYMEX
NYMEX Crude Oil Continuous
During February, prices dropped
and settled at $90.00.
160
140
120
100
XYZ Producer sells his physical crude
oil at $90.00 (avg. price for the month).
60
The lower price received for his
Physical crude is offset by the hedge.
40
$92.74 – $90.00 = $2.74 profit on hedge
20
$2.74 x 3,000bbls = $8,220
80
0
Net Price $92.74 ($90.00 + $2.74)
$11,400 + $8,220 = $19,620 Acct. Balance
www.devocapital.com
35
________________________________________________________________________
________________________________________________________________________
February 2014 Fixed Price Production Hedge
Prices rise
During February, prices rally and
settled at $95.00.
Source: NYMEX
NYMEX Crude Oil Continuous
160
140
XYZ Producer sells his physical crude
oil at $95.00 (avg. price for the month).
120
100
60
The higher price received for his
Physical crude is offset by the hedge.
40
$92.74 – $95.00 = ($2.26) loss on hedge
20
($2.26) x 3,000bbls = ($6,780)
80
0
Net Price $92.74 ($95.00 + ($2.26)
$11,400 - $6,780 = $4,620 Acct. Balance
www.devocapital.com
36
________________________________________________________________________
________________________________________________________________________
Options are a Form of Insurance
Buyer (Policy Holder)
• Pays premium (cost of the option)
• Receives right (to reimbursement if risk occurs)
Seller (Policy Writer)
• Receives premium (cost of the option)
• Takes on obligation (to reimburse policy holder if risk
occurs and policy holder files claim)
www.devocapital.com
37
________________________________________________________________________
________________________________________________________________________
Collar
A Collar is established by purchasing a floor and selling a ceiling
• Collars provide downside protection but upside participation
sacrificed.
• They are used to lock in a range of selling prices.
• They are used when producers are neutral to bearish on prices.
• Collars require credit, but less than that of a fixed price.
• Based upon proximity of the strike price to the current
market price
www.devocapital.com
38
Delta measures the sensitivity of the value of an option to changes in the price of the
underlying futures assuming all other variables remain unchanged. The closer the strike
price is to the underlying futures price, the higher the delta.
________________________________________________________________________
Pros and Cons of Collars
• Implement collar
• Pros:
- Establishes a floor at a reduced cost, especially if the market stays
unchanged
• Cons:
- Margin requirement
- Upside participation is capped
• Potential Follow Ups:
- Most often will settle based upon a pre-determined index level at a
pre-determined time
www.devocapital.com
39
Collars work well when the market is making the transition from a bull market to a
sideways to down market. Bull markets tend to die slowly. Executing a collar at this
time works well because it can decrease the cost of hedging if the market trades
sideways. Collars give the producer upside participation up to the call and downside
protection below the floor.
________________________________________________________________________
Collar Example-WTI Cal. Avg. Crude
Source: NYMEX
NYMEX Crude Oil Continuous
160
Producer purchases
5 Feb.14 CL $85.00
puts for $1.00…
140
120
$100.00
100
Locks in a “range”
80
…and sells 5 Feb.14
CL $100.00 calls for
$1.00
$85.00
60
40
20
0
By selling the calls, the producer is giving up his upside participation
above $100.00
This is an example of a “costless” collar and locks in a sales price between
$85.00 and $100.00.
www.devocapital.com
40
Costless Collar- The producer pays the same premium for the put options as the premium
collected for the call options. Example: paid $2.50 for puts and collected $2.50 for calls.
________________________________________________________________________
Collar Example – Prices Rise
Source: NYMEX
160
CL Prices
rise up and
settle at
$105.00
NYMEX Crude Oil Continuous
140
Prices rise to $105.00
$100.00 Ceiling
120
100
80
$85.00 Floor
60
40
20
0
The puts expire worthless as they are “out-of-the-money.” The calls are “inthe-money” and are assigned at $5.00 ($105.00-$100.00).
The producer would sell his CL at $105.00 in the physical market and pay
$5.00 to his financial counterparty. This would give him a net price of $100.00.
www.devocapital.com
41
This does not take into account DEVO’s Roll Up Strategy.
________________________________________________________________________
________________________________________________________________________
Collar Example – Prices remain stable
Source: NYMEX
NYMEX Crude Oil Continuous
160
CL Prices
remain stable
and settle at
$95.00.
140
120
$100.00 Ceiling
100
$95.00
80
60
$85.00 Floor
40
20
0
The puts expire worthless as they are “out-of-the-money.” The calls
expire worthless as well.
The producer would sell his crude at $95.00 in the physical market. The net
price would be $95.00.
www.devocapital.com
42
________________________________________________________________________
________________________________________________________________________
Collar Example – Prices Fall
Source: NYMEX
160
NYMEX Crude Oil Continuous
140
CL Prices fall
and settle at
$80.00.
$100.00 Ceiling
120
100
80
$85.00 Floor
60
40
Prices fall to $80.00
20
0
The calls expire worthless as they are “out-of-the-money.”
The puts exercised “in-the-money” and settle at $5.00 ($85.00-$80.00).
The producer would sell his CL at $80.00 in the physical market and the financial
counterparty would send the producer payment of $5.00. The net price would be
$85.00.
www.devocapital.com
43
________________________________________________________________________
________________________________________________________________________
Costless Crude Collar – Forward Curve
1/17/2014
Month
Year
WTI Cal Avg.
Price
Strike Price
WTI Cal Avg CL
Jan
2014
93.64
85.00
.01
96.00
.01
0
WTI Cal Avg CL
Feb
2014
94.04
85.00
.10
96.00
1.00
.90
WTI Cal Avg CL
Mar
2014
93.77
85.00
.48
96.00
1.69
1.21
WTI Cal Avg CL
Apr
2014
93.31
85.00
.98
96.00
2.13
1.15
WTI Cal Avg CL
May
2014
92.64
85.00
1.52
96.00
2.36
.84
WTI Cal Avg CL
June
2014
91.89
85.00
2.06
96.00
2.54
.48
WTI Cal Avg CL
July
2014
91.01
85.00
2.62
96.00
2.56
-.06
Commodity
Put
Premium
Strike Price
Call Premium
Call Prem. - Put
Prem.
WTI Cal Avg CL
Aug
2014
90.19
85.00
3.19
96.00
2.59
-.60
WTI Cal Avg CL
Sept
2014
89.49
85.00
3.73
96.00
2.65
-1.08
WTI Cal Avg CL
Oct
2014
88.82
85.00
4.21
96.00
2.68
-1.53
WTI Cal Avg CL
Nov
2014
88.25
85.00
4.64
96.00
2.72
-1.92
WTI Cal Avg CL
Dec
2014
87.49
85.00
5.11
96.00
2.65
-2.46
$91.21
$85.00
$2.39
$96.00
$2.13
$-.26
Average
www.devocapital.com
44
This is an example of a debit collar. The premium is to the put side and the producer
would have to pay a premium of $.26 to enter into this hedge.
________________________________________________________________________
Floor/Put
A floor is established by purchasing a strip of put options for
a series of months to establish a minimum selling price
• Buying puts gives the producer the option, but not the
obligation, to sell at a specified price (strike price).
• Floors are used to protect against a downside move, but
still participate in higher prices.
• Floors are used when producers are bullish on prices but
want protection in case prices move lower.
www.devocapital.com
45
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
Pros and Cons of Floors
• Purchase put options / floor
• Pros:
- No margin requirement
- Up-side participation
- Establish a minimum selling price at fixed cost
- Not as much of a basis risk
• Cons:
- Can be expensive if the market stays unchanged
- In most cases the protection does not kick in at current levels
- In most cases the premiums tend to be more expensive in OTC
relationships
• Potential Follow Ups
- Liquidate as they mature
- Set pre-determined liquidation levels
www.devocapital.com
46
Buying puts is a great strategy when the producer is trying to lock in a minimum selling
price for an extended period of time. Put purchasing can be expensive over time.
________________________________________________________________________
Floor Example – Prices Rise
Producer purchases
30,000 mmBtus/month
Feb.14 NYMEX NG
$4.30 puts for $0.11 on
1/17/14 ($3,300 cash)
Current Feb.14 Futures
are at $4.35
Source: NYMEX
NYMEX Natural Gas Continuous
$18
Prices rise
to $5.00
$16
$14
$12
$10
$8
$6
$4
$2
$0
Put option expires worthless = $0.11 loss of premium
Producer would sell his gas for $5.00 per mmBtu in the cash market.
The net effect of the hedge is a net sales price of $4.89 ($5.00 - $0.11)
www.devocapital.com
47
If the market rallies up, the producer has unlimited upside participation less the put
premium paid.
________________________________________________________________________
Floor Example – Prices Fall
Source: NYMEX
Producer purchases
30,000 mmBtus/month
Feb. 14 NYMEX NG
$4.30 puts for $0.11 on
1/17/2014 ($3,300 cash)
Current Feb. 14 Futures
are at $4.35
NYMEX Natural Gas Continuous
$18
$16
$14
$12
$10
$8
$6
$4
$2
$0
Prices fall
to $3.50
$4.30(strike price) - $3.50 (cash sell price) - $0.11 (premium paid) = $.69 per
mmBtu profit on puts. The $3,300 paid would now be worth $20,700.
The net effect of the hedge is a sales price of $4.19 ($4.30 - $.11)
www.devocapital.com
48
The producer is protected below their floor strike price less the put premium paid.
________________________________________________________________________
________________________________________________________________________
Option Combinations
Selling Short Term Premium
• Buying Puts (12 months)
• Selling Short term premium (3-4 months)
Advantages
• Have most of the upside participation
• Only risk posting margin on a few months
• Offsets some (but not all) of the cost of your puts
• Take advantage of the time decay curve
www.devocapital.com
49
Selling calls as a hedge strategy can help offset a producer’s cost of purchasing a floor or
increase producers profit margin
________________________________________________________________________
Selling Short Term Premium
Time Decay Curve
$per Barrel
Time Value
4.5
4
3.5
3
2.5
2
1.5
1
0.5
0
$3.75-$3.25=$.50
$2.50-$1.50=$1.00
0
30
60
90
Days till Expiration
120
www.devocapital.com
150
50
Selling call premium is designed to take advantage of the time decay of options. The
producer’s margin exposure is less than a traditional long term collar
_______________________________________________________________________
Option Combinations
Buying a Bear Put Spread
• Buying higher strike price puts (12 months)
• Selling lower strike price puts (3-12 months)
Advantages/Disadvantages
• Have the upside participation
• Offsets the cost of your long puts
• Limited downside protection
www.devocapital.com
51
Be careful selling puts. If the market falls below the producers short put strike price the
producer is no longer protected on the downside and this is when the producer needs
protection most.
________________________________________________________________________
Option Combinations
Three Way Collars (limited upside risk or limited downside protection)
• Buying puts and Selling calls (Collar for the desired term)
• Buy covering calls above the sold calls or
• Sell puts below the puts you purchased
Advantages/Disadvantages
• Offsets the cost of your long puts
• Have the upside participation above your covered calls (may cost more)
• Limited downside protection (only protected down to your sold put)
www.devocapital.com
52
Covered Calls- Gives the producer upside participation above the purchased call option
strike price.
Selling puts- Limits the producer’s downside protection but can increase profit margin
________________________________________________________________________
Understanding NGL’s and its market
Sustaining Oklahoma Natural
Resources
www.devocapital.com
53
NGL Products and Market Drivers
Gas Constituent
Molecular
Formula
Uses
Selected Market Drivers
Ethane
C2H6
• Ethylene (plastics)
• Consumer demand for plastics.
• International markets for ethylene.
Propane
C3H8
• Propylene (plastics)
• Residential and commercial
heating
• Consumer demand for plastics.
• Weather
• Transition to other heating fuels.
Butane
C4H10
• Propylene (plastics)
• Gasoline additive.
• Steady gasoline demand equals
steady demand for butanes.
Iso-Butane
C4H10
• Gasoline additive.
• Steady gasoline demand equals
steady demand for butanes.
Pentane+
(natural gasoline)
• Gasoline additive.
C5+
• Steady gasoline demand equals
steady demand for natural
gasoline.
www.devocapital.com
54
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
NGL Market Overview
www.devocapital.com
55
The NGL Composite Barrel has disconnected from Crude Oil in recent years due to the
sharp decrease in Ethane prices.
________________________________________________________________________
________________________________________________________________________
How to Hedge NGL’s
1. Priced off of a Mont Belvieu or Conway market?
2. Is not traded on the exchange but can be cleared to your NYMEX
account.
1. 42,000 Gallon contract size minimum
1.
All 5 streams are traded individually.
1. Ethane
2. Propane
3. Butane
4. Iso-Butane
5. Natural Gasoline
www.devocapital.com
56
The most efficient way for a producer to hedge their NGL’s is by locking in each
individual stream separately.
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
DEVO Strip Master Program
This program is designed to help evaluate and price various strips, floors, caps, and
collars. The program not only gives price indications for these various strategies
based upon NYMEX settlement prices, but will also calculate average net strip
levels based upon the option and futures prices. To have us construct a particular
collar for you, go to our website at www.devocapital.com.
Contract
Month
WTI Cal Avg
November
Year
2013
Futures
104.63
Put Strike
90
Put
.47
Call Strike
115
Call
.76
Call-Put
.29
WTI Cal Avg
December
2013
103.09
90
1.02
115
.97
-.05
WTI Cal Avg
January
2014
101.69
90
1.66
115
1.04
-.62
WTI Cal Avg
February
2014
100.49
90
2.30
115
1.15
-1.15
WTI Cal Avg
March
2014
99.31
90
2.88
115
1.21
-1.67
WTI Cal Avg
April
2014
98.35
90
3.44
115
1.25
-2.19
WTI Cal Avg
May
2014
97.34
90
3.94
115
1.22
-2.72
WTI Cal Avg
June
2014
96.44
90
4.37
115
1.27
-3.10
WTI Cal Avg
July
2014
95.58
90
4.84
115
1.26
-3.58
WTI Cal Avg
August
2014
94.83
90
5.27
115
1.28
-3.99
99.175
90
3.019
115
1.141
-1.878
Average
Call
-
Put
= Cost of Collar
57
The program is designed to help evaluate and price various strips, floors, caps, and
collars.
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
DEVO Capital – Research
Weekly Energy Outlook
Monthly Energy Report
Brent/LLS Newsletter
A weekly 12 page
comprehensive report that
covers the energy complex
and natural gas, complete
with fundamental and
technical analysis, as well
as specific hedge and trade
recommendations.
A monthly 21-page
research report that is
released mid-month.
This report includes a
comprehensive macro
view of worldwide
supply and demand
fundamentals.
A 3 page report that
tracks the Brent/LLS
differential, complete
with fundamental and
technical analysis and
trade
recommendations.
58
To reiterate our research is the lifeline between DEVO and our clients. Our reports
summarize the market moving news stories for the week, highlight key fundamental and
technical events and provide specific hedge and trade recommendations.
DEVO Capital – Research
Weather Service
Storage Report
This daily weather service by
meteorologist John Dee begins
the week with a 5-page
extensive report of past weather
patterns and forecasts out to 12
days. The weekly report is
followed by daily updates with
up to the minute changes.
This weekly report comes out
shortly after the storage
numbers have been released on
Wednesday (energy complex)
and Thursday (natural gas). It
includes historical graphs and
analysis of the weekly numbers.
NGL Newsletter
A comprehensive report that
covers all five natural gas
liquid streams with a frac
rate breakdown. The report is
complete with historical
prices, forward curves,
market outlook, and trade
recommendations.
59
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
Futures Disclosure Statement
This material has been prepared by a sales or trading employee or agent of DEVO Capital Management and is,
or is in the nature of, a solicitation. This material is not a research report prepared by DEVO Capital Management’s
Research Department. By accepting this communication, you agree that you are an experienced user of the futures
markets, capable of making independent trading decisions, and agree that you are not, and will not, rely solely on this
communication in making trading decisions. DISTRIBUTION IN SOME JURISDICTIONS MAY BE PROHIBITED
OR RESTRICTED BY LAW. PERSONS IN POSSESSION OF THIS COMMUNICATION INDIRECTLY SHOULD
INFORM THEMSELVES ABOUT AND OBSERVE ANY SUCH PROHIBITION OR RESTRICTIONS. TO THE
EXTENT THAT YOU HAVE RECEIVED THIS COMMUNICATION INDIRECTLY AND SOLICITATIONS ARE
PROHIBITED IN YOUR JURISDICTION WITHOUT REGISTRATION, THE MARKET COMMENTARY IN THIS
COMMUNICATION SHOULD NOT BE CONSIDERED A SOLICITATION. The risk of loss in trading futures and/or
options is substantial and each investor and/or trader must consider whether this is a suitable investment. Past
performance, whether actual or indicated by simulated historical tests of strategies, is not indicative of future results.
Trading advice is based on information taken from trades and statistical services and other sources that DEVO Capital
Management believes are reliable. We do not guarantee that such information is accurate or complete and it should not
be relied upon as such. Trading advice reflects our good faith judgment at a specific time and is subject to change
without notice. There is no guarantee that the advice we give will result in profitable trades.
Commissions have not been included in the examples. Commissions must be taken into consideration to reflect
accurate profit and loss. Commissions can vary depending upon the Futures Commission Merchant and the
broker you work with.
www.devocapital.com
60