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Derivatives: Not Just Hedges

Researchers find that 62% of derivatives used by oil and gas companies dont qualify for hedge accounting.

By Dave Lindorff | Updated on September 24, 2012
For decades now, companies have been hedging, especially those that are in the commodities business or depend heavily on commodities. But until recently, it was hard for outsiders to understand how companies used contracts. But in 2008, the Financial Accounting Standards Board’s Rule 161 required public companies to classify derivatives in their filings as either hedging vehicles or non-hedge derivatives. A team of academic accountants recently examined the filings of 87 oil and gas companies and found a remarkable amount of their hedging was actually economic, or speculative, in nature. According to their paper, “More than six out of every ten firms studied actually use the instruments for purposes other than managing risks.”

Swaminathan Sridharan, one of the study’s authors and a professor of accounting at Northwestern University’s Kellogg School, was surprised by the finding. “Some 62% of hedges in the oil and gas industry don’t qualify for hedge accounting.

“A true hedge should help to reduce earnings and cash flow volatility, but the hedges that are not really true hedges actually increase volatility,” Sridharan adds.

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