The use of nonlinear hedging strategies by US oil producers: Motivations and implications

- We study the motivations and real implications of nonlinear hedging strategies
- Sensitivities of investments and revenues to oil prices influence derivative choice
- Financial constraints have a non-monotonic relationship with the use of nonlinear hedges
- Oil production specificities and oil market conditions influence derivative choice
- The use of pure nonlinear hedges induces higher marginal firm value

This paper investigates the motivations and value effect of nonlinear hedges. Using a new dataset on the hedging activities of 150 U.S. oil producers, we present empirical evidence that nonlinear hedging strategies are motivated by sensitivities of firm's investment expenditures and revenues to oil price fluctuations, and quantity-price correlation. We also find a non-monotonic relationship between the use of nonlinear hedges and financial constraints. Investment opportunities, production uncertainty, and changes in oil prices and volatilities also play a significant role in hedging strategy choice. Controlling for bias related to omitted variables and self-selection in the estimation of marginal treatment effects of hedging strategy choice, we find that oil producers with a higher propensity to use pure nonlinear hedging strategies tend to have higher marginal firm value.