Reader Asks How "Hedging" Might Affect Mineral Owners' Royalties -- June 22, 2020

Updates

Later, 11:25 a.m. CDT: from a reader, see comments --

To get WTI future contract price, go to Marketwatch upper left, click on" Oil," scroll down and there are WTI contract prices for the next 12 months. Another link was on my "Data Links" page: CME. 

Original Post

A reader asked:

When oil companies hedge oil futures, do the mineral owners benefit from this, or do they get market price for that month?

At risk of looking like the fool I am, this was my reply, not ready-for-prime time:

Mineral owner royalties are based on the price the seller (the operator, in this case) gets for selling his/her oil to the buyer (usually a refinery).

Nearly 100% of oil sold to refiners is sold on a contract drawn up six months earlier between the seller and the buyer. The seller contracts to physically deliver a certain amount of oil to the refiner on a specific date for a specific price regardless of what the market is doing on the day of delivery.

Some operators, notably, according to public statements, like CLR, do not hedge. They simply contract to take the price of oil on the day the oil is delivered. Most sellers use hedges to protect against wild swings. I assume that CLR contracts with a refiner to deliver a certain amount of oil on a specific day for the "official" selling price that day (as determined at the hub: WTI, for example, at Cushing; I believe, Bakken is set at the Clearbook hub in Minnesota). It can be a big risk for both the buyer and seller to enter into a contract not knowing the price that will be paid. Perhaps those contracts also set limits on whether the buyer has to actually take delivery if the price is too high.

The WTI price seen in the TV crawler I believe is the "spot price" for that day. One can find the "price of oil" in the six month contracts -- I used to post those once in a while, but I've long forgotten where to find them. I'm sure it's not hard to find. It's those contracts that lead to articles in the mainstream financial pages about backwardation and contango.

But bottom line: mineral owners royalties are based simply on what the seller receives for his oil. It doesn't matter directly whether hedges were involved or not. Don't take that out of context. 

The NDIC in its monthly "Director's Cut" does provide the "average" price of oil that North Dakota operators received for light, sweet ND oil (Bakken oil) during that month. This number should be based on actually selling prices supplied by the operators. The state would be very, very interested in accurate data since that determines the state's royalties, also.

At least that's how I understand it. 

I'm sure the reader would appreciate corrections and comments to my reply.

Earlier today, just coincidentally, I posted this link at Bloomberg via Rigzone: the big oil turnaround. It begins:

Every day, traders in London congregate at 4 p.m. to buy and sell North Sea oil for half an hour. The window, as it’s known in the industry, is where competition between the most powerful players in the market sets the price of Brent crude.

Two months ago, every trader wanted to sell cargoes and none were keen to buy. Now the window has transformed into a bull market, where bids outnumber offers 10 to one and prices are surging.

I assume, but the article did not say, that the price agreed to during the 4:00 p.m. to 4:30 p.m. period in London is the official selling price for Brent the following day. From that number, contracts can then be drawn up for deliveries in the future -- six months out, for example -- as well as provide an official selling price for oil physically delivered the next day if not otherwise specified in a contract. Obviously, the difference between the "official selling price" and the contract price can further affect paper losses and profits. 

I assume the same thing happens in New York (the NYMEX) as in London.

I assume it's a bit like the stock market. All day long an equity is bought and sold based on what buyers and sellers agree to, but at the end of the day, the closing price becomes the "official" price fo that equity for that day. I don't know, but perhaps oil is traded back and forth on the spot market all day long, but then at the end of the day, the London group sets the daily Brent price so that everyone in the game is working from the same number.