share buy back announced, page-44

with so much volatility in POO atm i found this to be a good read......

NEWS ARTICLE
Believe it or not, oil companies don’t know where the price of oil is headed. And that’s why they hedge — sell a portion, often a substantial portion, of their future production at a fixed price that they figure they can live with.

This year has offered a textbook example of just how tricky it can be to predict oil and natural gas prices. Crude oil’s daily close on the futures market has been $87 to $145 a barrel in 2008, while natural gas has ranged from $7.25 and $13.58 per million British thermal units, roughly equivalent to 1,000 cubic feet of gas.

With many producers having committed billions of dollars to aggressive drilling and acquisition programs this year, prudence — and sometimes lenders — dictates that these companies insulate themselves from price fluctuations.

XTO Energy and Quicksilver Resources, for example, have hedged more than half and about 65 percent, respectively, of their expected 2009 production. Devon Energy, the biggest producer in the Barnett Shale, in 2008 hedged about 40 percent of its production.

Rick Buterbaugh, Quicksilver’s vice president of investor relations, said the company hedges to make sure that it has the money to drill.

"We tend to outspend our cash flow," he said, as do other independents during the exploration boom for new petroleum reserves like shale gas. "So we lock in prices" that the company knows will cover exploration and development expenses, he said.

Craig Pirrong, director of energy markets at the University of Houston’s Global Energy Management Institute, said: "The producers’ perspective is, if they don’t do anything, they live with the ups and downs of volatility. You give up the upside as protection against the downside."

In that regard, hedges looked like a boneheaded move earlier this year, when oil and gas prices rose relentlessly. Even worse, the companies were required by accounting rules to show big losses on their hedges, even though most of the loss was only on paper and didn’t reflect day-to-day operations.

For example, Chesapeake Energy took a $2.1 billion write-down on the value of its hedges just in the second quarter, when natural gas prices spiked. Range Resources took a $164 million write-down on its hedges.

But after June 30, the end of the quarter, prices plunged by nearly half from their peak in early July. Then hedges looked like a better idea.

During a conference call with financial analysts July 24, Range executives said they recalculated the worth of their hedges the day before, when the $164 million write-down would have been erased.

With that kind of volatility, most producers favor hedges that cost nothing upfront. Two hedging methods, swaps and costless collars, offer that.

Oklahoma City-based Devon uses both.

"They are very, very simple to use and do not cost us anything to put in place," said Darryl Smette, senior vice president of the marketing and midstream division.

Swaps

Two parties in essence "swap" ownership of the value of future production, Pirrong says. Like in most hedges, no oil or gas changes hands — it’s a financial arrangement. The deal is typically set up by a commercial bank that the producer already has a relationship with.

"The parties specify a fixed price, for example, $8 per million Btu, and a floating price, usually the New York Mercantile Exchange’s futures price" for natural gas, Pirrong said. The bank has now "swapped" the producer for the right to receive whatever the gas is worth on the futures market, while the producer has the right to receive $8, no matter what the market price.

If the futures price is $9 when the swap matures, the producer sells the gas for $9 — which goes to the bank. The producer gets $8. If the futures price is $7, the bank still pays the producer $8 but gets only $7 in return.

In practice, Pirrong said, either the producer or the bank simply pays the other party the difference in the value of all the natural gas covered by the swap.

Costless collars

Quicksilver uses costless collars to hedge much of its natural gas production at a minimum of $8.60 and ceilings of $10 to $13.50. The price is restricted, or collared, to a range rather than a specific price, as in a swap. It’s "costless" because the company buys a contract to sell its gas for the minimum price, but it also sells a contract for the right to buy its gas at the ceiling price. Between the two contracts, the company is out no money.

"If the price is between the floor and the ceiling, we just receive the price," Buterbaugh said. "If it goes below $8.60, we still get $8.60 for the gas," he said, but Quicksilver could get as much as the ceiling. "So we still have some upside," he said.