World oil prices have been rapidly swinging over the last few years, in part because of...

World oil prices have been rapidly swinging over the last few years, in part because of the declining value of the U.S. dollar, changes in supply and demand, and OPEC’s attempts to manage output in order to maintain higher prices. (OPEC stands for the Organization of Petroleum Exporting Countries) As the president of an oil producing and exporting company in Alberta: Explain how you may use hedging to protect your company’s income. Share a recent publication with your fellow students and your instructor.

Solutions

Expert Solution

As President of a company producing and exporting oil and gas in Alberta, it is essential to hedge against two variables: Price of Oil and the Value of domestic currency against dollar.

The hedging of oil price can be done by buying or selling oil futures on the commodity exchanges of the world. This insulates the company from wild swings in the oil prices to an extent. Although this increases the finance cost for the company.

Also the company can hedge through forward contracts/futures or currency options the value of dollar against its domestic currency. This ensures that the domestic revenue for the company remains largely insulated to the fluctuations in the currency. Also the company can set up a revenue stabilization fund into which any surplus may be contruibuted or drawdowns can be made in years of downtrend. This allows a smoothening of revenue and profitability for the firm.

Reference:
Landon, S., & Smith, C. (2010). Energy prices and Alberta government revenue volatility.

jeff jeffy answered 1 year ago

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