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OKLAHOMA CITY – Oklahoma could begin hedging its oil and gas revenue to protect against sharp and unexpected budget shortfalls like the state saw this year.

State Rep. John Michael Montgomery, who asked for an interim study to research the idea, said he wants to create more stability in gross production tax revenue. Hedging the income is like buying insurance, he said.

Montgomery, who is working with the state treasurer’s office to develop the idea, said he’s not sure yet how the financial instrument would work. In the abstract, though, it would be similar to hedges created by oil and gas companies.

After a year’s energy revenues are forecast, the state would hedge the estimate against investors.

“If we lock in a specific price, we protect from losses in revenue,” said Montgomery, R-Lawton.

It might also create an issue in state coffers if the price of oil beats the hedge, or is higher than the amount of money locked in by the state. Zhen Zhu, a professor of economics at the University of Central Oklahoma in Edmond, said hedging is about stabilization.

“If we implement a hedging program for state tax revenue, we have to be prepared for the case in which the product goes higher and we’re not going to be able to benefit from the higher price,” Zhu said.

He also said hedging creates a problem on the horizon – if the state bets that oil will remain at $60 per barrel for the next two years and the price keeps dropping, the state could see a dramatic loss in revenue at the end of the contract.

“This program can be effective in the short term to guard against unexpected price drops,” Zhu said. “But in the longer term, it’s not going to solve the problem.”

Another economist, Tom Seng, said the idea doesn’t make sense. An entity can’t place a hedge on something it doesn’t control, he said.

“The state would have to go out and enter into a financial swap with some entity,” said Seng, assistant professor of energy business at the University of Tulsa. “Well, the state doesn’t have any oil and gas to back that. I would love to see how he sees this being executed. Who are these financial institutions that are going to take this bet, so to speak, on oil prices?”

Seng said that a true hedge involves a physical commodity. Otherwise, he said, it’s speculative trading.

“If it’s somehow trying to stabilize the gross production tax receipts in the state, I cannot see how the state can do that, in any form or fashion, without truly being a pure-risk speculative situation,” he said. “I can’t see any financial instrument out there, any method that would guarantee the state a certain amount of gross production revenue.”

House leadership approved Montgomery’s interim study. It can be heard later this year.

JMA Energy owner Jeffery McDougall has advocated gross production tax revenue hedging to Oklahoma politicians for years. McDougall said he ensured the financial health of his own company by using hedges.

“I think it’s time the state start acting like an oil and gas company because they have a lot of oil and gas production,” he said. “If they’d had hedges on even since last Thanksgiving, they’d probably have several hundred million more dollars in their coffers.”

Without hedging, McDougall said, his company wouldn’t exist.

“If it’s good enough for all the oil and gas companies, why wouldn’t it be good for the state?” he said.

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