In just 12 days, Occidental Petroleum Corp pulled off one of the biggest hedges against falling oil prices ever placed by a U.S. energy company. It characterized the transaction as “costless” but a Reuters review of regulatory filings, market data and interviews shows that’s not the whole story.

The real price of Occidental's 'costless' oil hedge- oil and gas 360

Source: Reuters

The aim of the complex financial maneuver, the company said, was to help preserve Occidental’s generous dividend to shareholders as it sought to take over rival Anadarko Petroleum for $38 billion last summer in the biggest industry deal for years.

“With the additional leverage from the Anadarko acquisition, these new hedges will strengthen our 2020 cash flow in a low oil price environment, and provide additional assurance that our dividend is safe, while we are deleveraging,” Occidental’s Chief Financial Officer Cedric Burgher told an earnings call in August.

However, to secure the hedge swiftly and discreetly and to avoid paying its bankers a fee for arranging it, the company took a bigger potential hit to future revenues with only limited protection against falling oil prices, according to a source with direct knowledge of the transaction.

While Occidental disclosed the financial details of the hedge in filings, fulfilling its regulatory obligations, the fact that the company took on the additional risk to secure the transaction fast and to avoid banker fees has not been previously reported.

Occidental declined to comment for this story.

Hedges are used by a variety of companies. Airlines use them to protect against rising fuel prices and energy producers use them to lock in revenue, usually by buying a put option, a type of derivative contract, which gives them the right to sell oil at a predetermined future price.

Occidental used a complex series of transactions for its hedge, which was arranged by Bank of America Merrill Lynch and Citigroup, according to six sources with direct knowledge of the trades. The summer hedge covered nearly 110 million barrels of oil, or 300,000 barrels a day, each for 2020 and 2021, nearly enough to meet the annual oil imports of Australia.

Bank of America Merrill Lynch and Citigroup declined to comment.

For a graphic on how the hedge was executed, click on [].

The hedge meant the firm could sell the oil at a minimum of $55 a barrel in 2020, even if crude prices fell below that, to a limit of $45 a barrel; but the company’s selling price was capped at $74.09, and it would lose out on any revenue earned from oil prices rising beyond that mark.

Occidental capped revenues for 2020 and also 2021 but only got downside protection for 2020 – a lopsided deal sometimes referred to as a naked hedge. Limiting future revenue without getting a guarantee against falling prices is unusual in the energy sector.

While Occidental has disclosed the details of the 2020 hedge in regulatory filings, the absence of a hedge against falling oil prices in 2021 was not explicitly mentioned. The company said the 2021 options were meant to increase the maximum selling price it would receive for 2020 sales.

“Occidental entered into the 2021 call options to substantially improve the ceiling price that the Company will receive for the contracted commodity volumes in 2020,” it said in a filing.

Some analysts said investors should have been given more information about the potential implications of the hedge.

“It seems very strange that they left a naked hedge in 2021 which capped upside but offered no downside protection,” said David Katz, president and CIO of Matrix Asset Advisors, which owns 0.3% of Occidental’s shares.

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