Canadian banks owe $478 million US to firms that hedged oil prices

“If the banks haven’t hedged right, then they’re sitting on a pretty sizable liability. PETER ROUTLEDGE NATIONAL BANK FINANCIAL ANALYST

Canada’s biggest banks are on the hook for at least $478 million US of the $26 billion US owed to American oil and gas firms that bought protection against plunging crude prices.

Bank of Montreal, Canadian Imperial Bank of Commerce and Bank of Nova Scotia are among lenders that provided price protection for U.S. shale drillers that bought insurance against declines in energy prices when North American crude oil was above $90 a barrel. The Toronto-based lenders, which have all said they’ve hedged their risk with offsetting trades, must make good on the protection sold to wildcatters now that oil is trading around $56 a barrel.

Those lenders, along with Royal Bank of Canada and TorontoDominion Bank, had derivatives liabilities to U.S. energy companies including Energen Corp. and Pioneer Natural Resources Co. at the end of 2014, energy company records show. The amount owed is probably much higher than the $478 million reported in filings, as not all energy companies, including Canadian firms, disclose their hedging counterparties.

“If the banks haven’t hedged right, then they’re sitting on a pretty sizable liability,” Peter Routledge, a National Bank Financial analyst, said.

Canadian banks aren’t alone in being on the wrong side of energy hedges. Insurance, in the form of derivatives contracts, was also sold by Wall Street banks that financed the biggest energy boom in U.S. history.

The U.S. banks, just like their Bay Street counterparts, passed on the risk to hedge funds, airlines, oil refiners and utilities. The fair value of hedges held by 57 U.S. companies in the Bloomberg Intelligence North America Explorers and Producers index rose to $26 billion US as of Dec. 31, a fivefold increase from the end of September.

Financial institutions act as a go-between, selling oil derivatives to one company and buying from another while pocketing fees and profiting on the spread, says Charles Peabody, an analyst at Portales Partners LLC in New York.

“We actively hedge and manage our exposures to fluctuations in commodity prices,” said Anthony DeMartino, Bank of Montreal’s managing director and head of commodity trading.

Scotiabank’s market exposure is low and risk from customer contracts is hedged through offsetting transactions, said Mike Durland, group head and chief executive of global banking and markets. Tom Wallis, a CIBC spokesman, said the firm’s “practice is to hedge liabilities.”

Spokeswomen for Royal Bank and TD declined to comment on derivatives hedging beyond the bank disclosures.