Natural gas has always been one of the most volatile commodities. In other words, the natural gas market is, and will likely remain, prone to extreme price fluctuations. Volatile prices keep can have extreme effects on the bottom line of energy producers and consumers. That is why natural gas hedging for months or even years into the future is an important tool for companies, and when done effectively, provides a level of protection for a company’s bottom line. The fact of the matter is that risk management entails lots of effort coordination, and the use of a well thought out and organized hedge strategy that utilizes a statistical hedging program.

How Do Statistical Models for Hedging Come In Useful?

The correct decision regarding the timing and placement of natural gas hedges is largely dependent upon a company’s goals and risk appetite. Therefore, the creation of a hedge strategy based on a statistical model is a wise decision. This will provide you real-time scientifically analyzed data to help better understand the energy market’s price cycles. In this manner, the model you us, gives you the confidence of making the right decisions with regards to timing hedges, the right maturity to use, and the best derivates to meet your strategic objectives.

Most Businesses Ignore Statistical Models

Many companies rely on speculative hedging strategies based on long-term forecasts that are marketed by trading desks. While it is fine to listen to these strategies, blindly accepting the exact trade that is being recommended is rarely an effective means of doing natural gas hedging. It is more important to run in-depth statistical models to ascertain what a hedge will do under various market conditions.

Many companies are surprised when they are asked to use statistical models. They don’t realize it is urgent that these models are not only developed and analyzed before executing a hedge but in addition, updated and analyzed on a routine basis. Sadly, many multinational companies have been pushed to the brink of bankruptcy due to exceedingly speculative trading, in the guise of hedging, without understanding the full ramifications of their "hedge decisions”.

As to issues that emerge when natural gas prices increase or decrease significantly, the point is to be vigilant about are the following:

1) Untested hedge techniques can be disastrous.

2) Producers and consumers that need to buy or sell large quantities of natural gas should stress test their hedge strategy. This will help to discern the financial implications of individual positions, as well as the entire hedge portfolio, in different market scenarios. This must incorporate not only their exposure to price risk but also the credit and operations risks.

Conclusion

The use of a statistical model is a good strategy for natural gas hedging and can help to bring certainty to hedging decisions. Moreover, hedging needs thorough assessment of the past and the potential for the future through analysis, which is possible by using an updated and rigorously tested strategy based around a statistical hedging model?

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