Hedge AccountingThis conversation was getting painful:
Hedged or not hedged, VET sells its product into the market, at the prevailing market price.
The swaps are financial contracts, which settle on a cash for difference basis.swap WTI at $60, and it closes at $70, I pay $10 per barrel x the number of hedged barrels in cash to the holder of the contract. Real cash, out the door each month -> these are the Realized Losses, and they are tax deductions, against the gains made on the market revenue realized.
The Calls and Puts are different, if I sell a call at $70, than the buyer of the call has the right to buy that oil at $70 from me at Options expiration (or before, depending on call option type). In most cases, those are also settled for difference.
Now, the big loss on the Income statement comes not from the Realized Losses, but from the unrealized losses on ALL THE FUTURE HEDGES ON THE BOOK, marked to market each quarter.
So, if a producer had 10 years worth of $50 oil swaps, and the quarter ended at $70, then not only the $20 per barrel loss realized in the Quarter, but the remaining 9.75 years of losses of $20 a barrel + time value would be an income statement hit, in that quarter.
Non cash hit. If the price went back to the hedge price of $50 next quarter, than the entire 9.5 years of losses would reverse, and the producer would have a huge unrealized hedging gain in the quarter. If prices stayed the same, than there would essentially be no additional hedge loss.
The one quarter of losses would become realized, the remaining 9.5 years losses would be lower, leading to a gain in the Mark to Market position.
For sophisticated investors unrealized heding losses are just noise.