Why hedging programs make these mistakes
Natural gas hedging mistakes rarely come from picking the wrong instrument. Swaps, calls, collars, and basis swaps are well understood tools. The math behind each is public. Any competent treasury can read a term sheet.
Programs fail from procedural errors that compound quietly until an extreme event exposes them. A wrong index selection that seemed like a minor liquidity trade-off. A hedge ratio that was never updated. Documentation that never got completed. These small compromises accumulate. Then a winter storm arrives, or a hurricane, or an LNG terminal shutdown, and the treasury discovers the program was fragile long before the event.
The CFE Goldman Sachs case is the most public example of what accumulated errors look like at scale. It involved a $300 million settlement over a daily-versus-monthly index mismatch in a natural gas supply contract. But smaller versions of these same errors sit inside industrial hedging programs across Mexico right now, waiting for the next event to reveal them.
This post covers six errors that appear repeatedly in Mexican industrial hedging programs. The natural gas hedging guide for Mexico covers the broader strategic framework. Here we focus on what goes wrong in practice.
Hedging the wrong index
The most expensive documented hedging mistakes in Mexico involve index mismatch. The CFE case established the extreme version. A supply obligation tied to the daily Waha index, hedged against the monthly Waha index. When the February 2021 Texas winter storm pushed daily Waha to $206 per MMBtu while the monthly index stayed near $5, the mismatch created an instant liability.
The same error appears at smaller scale, every day, across Mexican industry. A glass manufacturer in Monterrey signs a supply contract indexed to HSC plus a fixed differential. The treasury decides to hedge with Henry Hub futures because Henry Hub has better liquidity and tighter bid-ask spreads. The reasoning sounds fine on paper. In practice, when HSC decouples from Henry Hub (which happens during hurricane season, LNG terminal outages, or Gulf Coast supply disruptions), the hedge moves with Henry Hub while the actual cost moves with HSC. The gap between the two is the loss the hedge was supposed to prevent.
Basis risk is the silent gap in every mismatched hedge. Most of the time the two indexes move together, so the mismatch produces no visible cost. Then a single event exposes years of accumulated basis exposure at once.
The rule is simple to state and hard to enforce internally. The index of the hedge must match the index of the physical exposure. If the supply contract references HSC, hedge HSC. If Waha, hedge Waha. Liquidity is not a valid reason to substitute. If HSC liquidity is a real constraint, the correct solution is a Henry Hub hedge plus a separate HSC-to-HH basis swap, not a raw Henry Hub position pretending to cover HSC exposure. The natural gas indexes used in Mexico guide covers this in detail.
Not updating the hedge when volume changes
The second of the hedging mistakes we see repeatedly is treating hedge coverage as static when the underlying exposure is not. Physical exposure moves constantly. Production ramps for seasonal demand. Long-term supply contracts expire and renew at different volumes. New production lines open. Facilities shut for maintenance or unplanned outages. Each change shifts the volume that needs coverage.
When the hedge does not move with the physical exposure, one of two things happens. Overhedged: the company holds derivative coverage on volume it no longer consumes. If prices fall, the excess coverage now creates losses without matching gains on the physical side. This looks like speculation on the P&L, and boards react.
Underhedged: the company is exposed on volumes that were added after the hedge was set. When prices spike, the uncovered portion drives cost overruns that the hedging program was supposed to prevent. The board asks why the hedge did not protect the additional volume, and the treasury discovers the answer was budget-cycle timing that never got revisited.
The minimum acceptable practice is quarterly review. Every quarter the treasury reviews physical exposure changes, compares to hedge coverage, and adjusts the ratio. For volatile-demand industries (manufacturing with cyclical output, power generation with weather-driven demand), monthly review is more appropriate. Programs that review once a year systematically underperform because the exposure has changed multiple times before the annual check catches it.
Ignoring IFRS 9 documentation
This one of the hedging mistakes is subtle. It rarely comes from ignorance. It usually comes from delay. Hedge accounting documentation under IFRS 9 is technical, time-consuming, and requires coordination between treasury, accounting, external auditors, and often external advisors. Many treasuries postpone the documentation and hedge anyway, planning to complete the paperwork later.
The consequence is direct. Without qualifying hedge accounting documentation, the mark-to-market of the derivative hits P&L directly each reporting period. The underlying exposure does not create an offsetting P&L entry because the physical gas cost only flows through when consumed. The result is accounting volatility that has nothing to do with economic reality but everything to do with what the board sees on the income statement.
The predictable response is fear. Boards see quarterly derivative losses and demand explanations. Auditors ask questions about risk appetite. Treasury departments get pressured to reduce hedging, or to hold shorter tenors, or to avoid options entirely. The hedging program shrinks not because the economic exposure got smaller, but because the accounting made the program uncomfortable.
The solution is not to hedge less. The solution is to invest in the documentation. Proper IFRS 9 hedge accounting documentation eliminates the mismatch and lets the derivative P&L match the underlying exposure over time. This is a solvable problem that pays for itself the first time an extreme event validates the coverage.
Confusing hedging with speculation
Hedging locks in a price for a known physical volume. The purpose is to convert uncertain cost into certain cost. The derivative offsets the physical exposure. Both move together, and the net effect is stability.
Speculation locks in a price for a directional view without an underlying volume. The purpose is to profit from a market movement. There is no physical offset, so the derivative alone determines the outcome. Movement in either direction produces gains or losses independent of any operational reality.
This is one of the hedging mistakes treasuries make without recognizing it. The most common way is doubling the hedge ratio when the treasurer or CFO has a strong view that prices will rise. The rationale sounds like risk management (“we need more protection because prices are going up”), but the extra coverage above the physical volume is speculation. If prices rise as expected, the extra coverage generates gains and the CFO looks smart. If prices fall, the extra coverage generates losses without matching physical relief, and the P&L shows what speculation looks like.
The distinction in practice is a discipline of volume. Every hedge position must correspond to a specific volume of expected physical consumption during a specific period. If the hedge exceeds the consumption, the excess is speculation, regardless of how the treasury frames it internally. This test is uncomfortable because it exposes decisions treasuries would rather not label. But applying it prevents the drift from hedging to speculation that most programs experience under market pressure.
Bad timing under pressure
Timing decisions made under pressure produce the costliest hedging mistakes. Yet most Mexican industrial buyers approach hedging reactively, hedging only after a price shock has already occurred.
The February 2021 Texas winter storm illustrates the pattern. HSC prices reached $400 per MMBtu at the peak of the event. Companies that had no hedging in place before the storm faced an impossible choice: pay the spot price and absorb the cost overrun, or hedge at the peak and lock in the worst possible price. Treasuries under CFO pressure to “do something” often chose to hedge at $400 or $300, only to see HSC return to $4 within three weeks. They locked in the spike and got no protection from the reversal.
The pattern repeats every summer during hurricane season. When a named storm enters the Gulf of Mexico, options premiums spike immediately. Buyers who had no coverage in place scramble to buy calls at prices that already include the expected disruption. Three weeks later, when the storm has passed and prices settle, those calls expire far out of the money.
The discipline is preparation. Hedges should be set before events, not during. Coverage established in May at fair volatility premiums provides real protection when August storms arrive. Coverage attempted in August at elevated premiums provides expensive false security. The knowing when to hedge natural gas guide covers the framework for pre-positioning versus reactive hedging in more detail.
No periodic review compounds hedging mistakes
A hedging policy written three years ago and never updated is not a policy. It is a historical document that happens to still govern trading decisions. Yet many Mexican industrial companies operate this way, hedging under policies whose original assumptions no longer match reality.
Three things drift over time. Physical exposure changes: new production lines, expired supply contracts, adjusted offtake terms. The market regime changes: what looked like normal volatility in 2022 became suppressed volatility in 2024. And the instrument availability changes: new products appear, existing products become more or less liquid, and counterparty relationships evolve.
Without periodic review, none of these changes get incorporated. The treasury continues to hedge under assumptions that no longer describe the business. Coverage ratios that made sense at previous production levels leave newer volumes uncovered. Instruments that were optimal three years ago may no longer be the best fit for current market conditions.
The minimum discipline is two levels of review. An annual formal review at board level reassesses the entire hedging policy, including strategic goals, coverage targets, and instrument approvals. A quarterly operational review at treasury level checks execution, coverage ratios versus current exposure, and adjustments for the coming quarter. Programs with only annual review consistently trail programs with quarterly operational rhythm.
Most of the hedging mistakes covered in this post start with the absence of periodic review. Wrong index selection persists because no one revisits it. Volume mismatches accumulate because the ratio never gets checked. Speculation drift happens because the discipline of matching hedge to physical volume never gets enforced. Periodic review is the mechanism that prevents each individual mistake from compounding into a program-level failure. For companies that recognize their program needs a diagnostic review, the contact page is the starting point.