A Lesson in Texas Hedging

$82.09 was the closing price of the front-month crude oil contract on October 23, 2014.

I attended a Denver Broncos game that day. Before I get into my story, we need a little background.

I’m guessing you’re familiar with the term “Texas hedging”. If not, it typically refers to a situation when a farmer buys futures contracts on top of their already “long” position in the field or in the bin. A high reward and high risk endeavor. Any Texas hedging done by farmers over the last 2-3 years has likely been very painful.

Back to my story. I was invited to sit in a suite at the Broncos game I attended in October 2014. The suite was occupied by an oilfield services company. Based on my introductions, the majority of the attendees were executives or managers of many oil and gas companies operating in the central US.

I was intrigued to hear many of the oil industry executives talk about which oil and gas company stocks they and/or their colleagues were buying.

An oil and gas executive, who’s compensation is highly levered to the future price of oil, is buying oil and gas stocks?? A prime example of Texas hedging.

At the time, oil had dropped over $20/bbl. from the $100+ levels experienced during the summer of 2014. I got the impression that these guys felt like they were lucky to have the opportunity to pick up these stocks at attractive price levels. It felt like a “buy them while you can!!” moment. Here are a few of the stocks that were mentioned.

• Oasis Petroleum
• Triangle Petroleum
• Whiting Oil and Gas

Lets compare the stock prices then to the prices today.

• Oasis Petroleum: $30.93 vs $4.23 (a decline of 86%)
• Triangle Petroleum: $8.24 vs $0.38 today (a decline of 95%)
• Whiting Oil and Gas: $63.40 vs $5.00 (a decline of 92%)

We need to take this with a “hindsight is 20/20” grain of salt. No one projected that crude oil would fall as far as it has fallen over the last 12 months. Consistently predicting future commodity prices is next to impossible.

What can we learn from this story?

1. Don’t Texas hedge! It’s a recipe for disaster.
2. Diversify when possible.

Just because a person is familiar with an industry doesn’t give them the ability to predict the financial markets related to that industry.

Remember this the next time you hear about someone “killing it” with their Texas hedging strategy.