Evaluating oil and gas investments for a private equity firm
An upstream natural gas producer carried costless collars across four lender-counterparties under its credit-facility hedge requirement. It decided to convert them into fixed-price swaps, and the instruction was one line: execute all of them at the levels quoted.
Two of the four quotes failed the same test. One counterparty quoted the replacement swap two cents below the floor the client already owned. The other quoted it at exactly that floor — the entire call spread surrendered, and nothing received for it. One offered nothing for the client's upside; the other offered less than nothing.
Both quotes were inconsistent with put/call parity. Neither reconciled with the economics of the existing collars. Without independent valuation, both would have been filled as quoted.
We didn't trade. Neither of them.
The orders were live, written and unambiguous, and a transaction-based compensation model creates an economic incentive to complete the trade. Instead we held both, priced the conversions on the desk against our own comprehensive valuation model, and went back to each counterparty with those marks and our cross-counterparty pricing to ask them to justify the level.
That modeling step is the whole case. A conversion is a restructure: its value depends on both legs of the collar the client already holds, priced against a live volatility surface, and on the swap that would replace them — the two valued together as one position. That interaction is where the nuance sits, and where a subject matter expert makes the difference. The day-to-day of a hedge program is a different job: M-Direct gives producers real-time indicatives on swaps, collars and three-ways, so a price can be checked in seconds ahead of a bank call.
Two further things made the catch possible. The same structure is worked across the client's full bank group simultaneously, which turns a judgment call into a measurement — and is the only reason the second quote surfaced at all. And because our compensation is not tied to executed volume, holding an approved order costs us nothing.
Both counterparties reviewed their pricing and raised their bids: five cents on one, three and a half on the other.
$47,251 in transaction cost avoided across the two trades — on orders the client had already approved. Neither was bad faith; the quotes were off, and neither side had an independent reason to challenge them until we did.
The wider point is the count. One quote out of line is bad luck. Half a bank group mispricing the same structure on the same morning is a structural condition, and it is the condition every producer hedges inside of — most visibly on the complex transactions, where the nuances of the structure decide the number.
Single anonymized client transaction; economics as executed. Not representative of typical results. Not an offer, recommendation, or investment advice. Derivatives involve risk of loss.