Natural gas investors misunderstand Birchcliff market diversification using "basis" hedges

They are reasons for smiles, not tears

Birchcliff Energy (BIR.TO) eschews fixed price hedges but enters into risk management contracts that ensure it enjoys market diversification at improving prices relative to Henry Hub and a degree of interest rate protection. The Birchcliff risk management disclosure appears below:

For the balance of 2023, the company will receive a price for 147,500 MMBtu/d of natural gas equal to the Nymex price of US$2.93 (as of today) less a basis “hedge” equivalent to a fixed price for notional transportation of US$1.227 or a realized price in Canadian dollars of 2.93-1.227 times 1.37 (exchange) = CAD$2.33, more or less equal to the current AECO price. As the Nymex prices fluctuates, so will the price Birchcliff receives for that portion of its natural gas output. Another 5,000 MMBtu/d will receive Nymex less US$1.205 until year end.

During 2024, the “basis” hedge drops by a dime, meaning Birchcliff will get a relatively higher price for its natural gas. Think of it as the equivalent of a lower transportation price. The “basis” hedge keeps dropping through 2027 when the relative price improves by CAD$0.60 per Mcf.

Birchcliff has some debt on its balance sheet and has wisely fixed the rate on that debt at the Canadian Dollar Offered Rate (CDOR) for one-month bankers acceptances at 2.215% until March of 2024. The CDOR is currently just over 5.17%.

Year to date 2023 Birchcliff has booked a CAD$29 million realized loss on these risk management contracts. I expect the company will book gains on risk management in 2024. A lot depends on the auction at Henry Hub and the path of Canadian interest rates. But the narrowing natural gas “basis” hedges mean that Birchcliff realized natural gas prices on the volumes so hedged will improve relative to 2023 and to the Nymex price which typically is the benchmark for the industry.

Natural gas markets are local, not national, and prices at AECO, Dawn, Alliance, and Henry Hub can differ widely. What Birchcliff has done is diversify its markets.

In my opinion, that diversification will produce a net benefit in 2024. If the coming winter turns out to be a cold one, the benefit will probably be worth the candle.