The Value Effect of Crude Oil Derivatives Transactions by Oil Producers

Abstract

Previous studies show that crude oil is negatively correlated with stocks but has almost the same rate of return as stocks, and so adding crude oil into a portfolio with equities can provide significant diversification benefits for the portfolio. Given the diversification benefit of crude oil mixed with equities, we examine the value effect of crude oil derivatives transactions by oil and gas producers. Differing from traditional corporate risk management literature, this study examines corporate derivatives transactions from the shareholders' diversification perspective. The results show that crude oil derivatives transactions by oil and gas producers do impact value. If oil and gas producing companies stop shorting crude oil derivatives contracts, company stock prices increase significantly. In contrast, if oil and gas producing companies initiate short positions in crude oil derivatives contracts, stock prices drop marginally significantly. Thus, hedging by producers is not necessarily good. Transaction limitation is shown to be one of the possible sources of the value effect of corporate derivatives transactions.