In just 12 days, Occidental Petroleum Corp. pulled off one of the biggest hedges against falling oil prices ever placed by a U.S. energy company. It characterized the transaction as "costless" but a Reuters review of regulatory filings, market data and interviews shows that's not the whole story.

The aim of the complex financial maneuver, the company said, was to help preserve Occidental's generous dividend to shareholders as it sought to take over rival Anadarko Petroleum for $38 billion last summer in the biggest industry deal for years.

"With the additional leverage from the Anadarko acquisition, these new hedges will strengthen our 2020 cash flow in a low oil price environment, and provide additional assurance that our dividend is safe, while we are deleveraging," Occidental CFO Cedric Burgher told an earnings call in August.

However, to secure the hedge swiftly and discreetly and to avoid paying its bankers a fee for arranging it, the company took a bigger potential hit to future revenues with only limited protection against falling oil prices, according to a source with direct knowledge of the transaction.

While Occidental disclosed the financial details of the hedge in filings, fulfilling its regulatory obligations, the fact that the company took on the additional risk to secure the transaction fast and to avoid banker fees has not been previously reported.

Occidental declined to comment for this story.

Hedges are used by a variety of companies. Airlines use them to protect against rising fuel prices and energy producers use them to lock in revenue, usually by buying a put option, a type of derivative contract, which gives them the right to sell oil at a predetermined future price.

Occidental used a complex series of transactions for its hedge, which was arranged by Bank of America Merrill Lynch and Citigroup, according to six sources with direct knowledge of the trades. The summer hedge covered nearly 110 million barrels of oil, or 300,000 barrels a day, each for 2020 and 2021, nearly enough to meet the annual oil imports of Australia.

Bank of America Merrill Lynch and Citigroup declined to comment.

The hedge meant the firm could sell the oil at a minimum of $55 a barrel in 2020, even if crude prices fell below that, to a limit of $45 a barrel; but the company's selling price was capped at $74.09, and it would lose out on any revenue earned from oil prices rising beyond that mark.

Occidental capped revenues for 2020 and also 2021 but only got downside protection for 2020—a lopsided deal sometimes referred to as a naked hedge. Limiting future revenue without getting a guarantee against falling prices is unusual in the energy sector.

While Occidental has disclosed the details of the 2020 hedge in regulatory filings, the absence of a hedge against falling oil prices in 2021 was not explicitly mentioned. The company said the 2021 options were meant to increase the maximum selling price it would receive for 2020 sales.

"Occidental entered into the 2021 call options to substantially improve the ceiling price that the Company will receive for the contracted commodity volumes in 2020," it said in a filing.

Some analysts said investors should have been given more information about the potential implications of the hedge.

"It seems very strange that they left a naked hedge in 2021 which capped upside but offered no downside protection," said David Katz, president and chief investment officer of Matrix Asset Advisors, which owns 0.3% of Occidental's shares.

However, other analysts said Occidental needed to secure a hedge quickly to defuse some of the pressure from investors.

“Doing this gives Oxy a lot of flexibility in 2020 with cash flow," said Trisha Curtis, president of PetroNerds, an energy analytics and advisory firm specializing in U.S. shale.

"You can’t have an acquisition that big and then willy-nilly hope that oil prices hold up. Regardless of what it cost them, it was needed for a number of reasons."

Revenue-Limiting Options

Occidental has said publicly that it does not regularly hedge its oil sales because it does not want to give up potential revenue. The last time the company hedged was in 2005, also following an acquisition.

In the summer of 2019, Occidental was under pressure to demonstrate that its dividend was being protected.

Billionaire activist investor Carl Icahn was campaigning against the Anadarko deal and Anadarko itself had issued a regulatory filing on July 29 saying its calculations showed that Occidental, even without an acquisition, would not be able to generate enough cash to pay its dividend for the next three years.

Occidental executives wanted to be able to announce the hedge to reassure investors when they presented second-quarter results on July 31, according to three sources with direct knowledge of the transaction.

Bank of America and Citigroup had been advising Occidental on the Anadarko acquisition. Now their traders had about two weeks to complete the hedge.

Acting on Occidental's behalf, Bank of America Merrill Lynch and Citigroup sold two types of derivative contracts, with the intention of using the proceeds from the sales to fund the purchase of a put option locking in Occidental's oil revenues at $55 a barrel for 2020, according to the six sources.

In illiquid private markets, big transactions are more difficult, and therefore more expensive, to execute. If rival traders get wind of a deal before it is fully executed, they could get in first with their own buy or sell orders, pushing up or down the target price.

In the case of Occidental's hedge, the large volume of oil and the tight time frame to insure it meant the banks were not going to be able to raise enough money from selling derivative contracts for 2020 alone to cover the cost of the hedge, the first source said.

To fill the gap and avoid having to present Occidental with a large bill, the banks sold similar revenue-limiting options for 2021, the source said.

Selling the 2021 options also increased the amount of money the banks could make because they were selling additional contracts on Occidental's behalf.

Derivatives trades require only minimal disclosure and it is unclear how much of a profit the banks made from the Occidental deal.

In the first week of 2020, international oil prices spiked by around 9% to nearly $72 a barrel due to heightened tensions in the Middle East. They have since fallen back to around $65, $2 above the price they are expected to average out at over 2020, according to the most recent Reuters poll.

If those expectations pan out, Occidental will not miss out on potential profits, so the bet would work out. On the other hand, if oil prices were to surge again, and remain above $74 a barrel, the cost to Occidental could translate to millions of dollars a month in lost revenues, even at just $1 above the price cap.

Despite the hedge underpinning its dividend, Occidental shares have fallen by nearly a third since April, when its interest in Anadarko first became public.