Many upstream oil and gas companies enter into derivative contracts to hedge some of their commodity price risk. This article serves to explain how to explain the basics of the types of hedges that exist and how they affect a company’s cash flows.
One of the most common types of hedges that upstream companies enter into is called a “collar.” A collar both limits a portion of a company’s downside and a portion of a company’s upside. The following table is from Range Resources’ 2012 10-K. The company stated that for 2013, it had hedged 280,000 MMBtu/day (millions of British thermal units per day) of natural gas with collars at $4.59-5.05/MMBtu. This means that even if natural gas prices fall below $4.59/MMBtu, the minimum that RRC would receive is $4.59/MMBtu on 280,000 MMBtu/day of production.