Counterparty Risk and Liquidity Concerns

April 1, 2020July 28th, 2020
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Banks and swap dealers owe producers a lot of money on hedging gains. Should anyone worry that they can pay?

Global market conditions have caused investors to make a dash for cash, raising questions about counterparty abilities to provide liquidity with most producer hedge books deep in the money. Additional concerns also surround a bank or swap dealer’s chance of defaulting given the tumultuous conditions across all financial sectors.

Without commenting on any specific bank or swap dealer, there are several actions that counterparties take which not only mitigate their own risk, but also allow AEGIS clients the ability to monetize their positions if needed.

First, banks typically reduce their price exposure by executing an offsetting trade through a cleared market exchange. For example, a bank may purchase a swap from a producer, but they will mitigate their risk by also selling a swap on ICE or CME exchanges. For counterparties with a physical-trading operation, financial price risk could be offset through physical positions.

Since the passage of the Dodd-Frank regulations, markets have considerably-less tolerance towards risk. The capital requirements to transact are much higher, meaning the credit of companies should be of a higher grade, ensuring greater financial stability.

From a client perspective, AEGIS recommends having multiple counterparties. In fact, we often facilitate introductions with counterparties. This not only reduces the exposure, and thus risk, from one specific bank or dealer, but it also encourages more competition on bids when executing hedges. Clients are able to view their counterparty mix on AEGIS Flow at any time.

Below is a chart of counterparty share of AEGIS clients’ hedges. Note that most are among the highest-rated banks and trading houses. Smaller, regional banks make up a much smaller share.

AEGIS recognizes that counterparty risks have grown given the current market environment. However, we note that counterparty risk is not as pronounced as it once was, both due to regulation and swap dealers’ trading habits.

We continue to monitor oil, gas, NGLs, and regional markets for hedging opportunities. To learn more and see AEGIS opinion and recommendations, go to AEGIS View publications, or contact info@aegis-energy.com. Like what you see? Share this article with the button on the bottom right of your desktop. Market questions or comments? Contact us at view@aegis-energy.com

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NOTICE: The content of this report is provided for information purposes only and has been prepared to describe current trends in the commodities markets. This information does not constitute either investment or hedging advice and is intended only for AEGIS clients. If you are not the intended recipient of this report, then you may not disclose, print, copy or disseminate this information. Otherwise, if you have received this transmission in error, then please notify the sender and delete the report.

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