The Hedging Effectiveness of Brent Crude Oil Futures Contracts

Abstract

Many different papers document the hedging effectiveness with the use of futures contracts, and this paper presents the analysis of the hedging effectiveness of Brent crude oil futures contracts of different estimation models and maturities. The intention is to find the most appropriate futures contract an oil producer should implement in its hedging strategy. Further, the purpose of this paper is to propose an optimal hedging strategy for the risk management that handles Brent crude oil. The hedging performances of the different models and maturities are compared, and the findings indicate that the three-monthly contracts of naïve hedge ratio model have the highest performance in reducing price risk, which is the model that also provides the lowest costs. This contradicts other empirical frameworks that find the futures contracts of shortest maturity most efficient. In the analysis, another finding is that a segmentation of the time series according to historical events, such as the financial crisis and the price fall in 2014, shows that there are changes in the hedging effectiveness. Also, an out-of-sample model that forecasts spot prices provides a prediction of the future hedging effectiveness. Despite limited information about the future, the forecasted hedging effectiveness captures approximately 90% of the actual hedging effectiveness, and gives an average deviation of only ten percentage points.