Derivatives: Not just for hedging

Researchers find 62% of derivatives used by oil and gas companies don’t qualify for hedge accounting.

The researchers say the market performance of the companies studied suggests such practices don’t fool investors. “We find the market penalizes those companies that use non-hedge-designated derivatives,” Sridharan says.

Ira Kawaller of Kawaller & Co.At least one accounting expert questions the study’s conclusions. “I suspect there is some speculative use of derivatives going on here, but I think the reason for most of the non-hedge accounting is that companies simply get sick of trying to comply with Rule 161,” says Ira Kawaller, principal of Kawaller & Co. and former vice president of the New York office of the Chicago Mercantile Exchange.

While FASB’s goal of preventing companies from using hedging to hide real gains and losses was laudable, the regulator ended up making compliance with the rule “too onerous,” says Kawaller, pictured at right.

Lars Lochstoer, a finance professor at Columbia Business School who has also been examining derivative use by the energy industry, says he’s surprised at the extent of non-hedging use, but adds, “When I talk with people in the oil industry, they think they have better knowledge of the market and want to take advantage of it, so it’s not surprising that they are trading on that information advantage.”

Sridharan says the study did not analyze the specific purposes of the non-hedge derivatives. But his team plans to expand its research to look at a sample of 1,500 companies that will include businesses in a number of industries besides oil and gas that are also heavily reliant on commodity markets.





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