If you’re a relative newcomer to investing in the energy sector, then the sharp selloff in crude oil since late September has been an understandable shock.

Although North American crude oil benchmark West Texas Intermediate (WTI) has risen slightly from its recent low, it’s still down about 9.1 percent since the end of September. Over that same period, the S&P/TSX Energy Index has essentially mirrored this decline, falling by about 9.4 percent in US dollar terms.

Of course, recent downward momentum in crude oil prices exacerbated a trend that had already been underway since midyear. The price per barrel of WTI crude peaked near USD104 in late June before beginning the protracted swoon that culminated in the recent selloff.

Over that period, WTI is down about 20.2 percent. Meanwhile, Canadian heavy crude benchmark Western Canada Select (WCS) has fallen by about 20.7 percent in US dollar terms since its mid-June high.

Owing to the fact that WCS is a heavier grade of crude than light WTI and therefore costlier to refine, the former tends to trade at a persistent discount to the latter. Transportation bottlenecks at key pipelines have also contributed to pricing differentials between the two commodities in recent years.

But over the past year, that differential has narrowed considerably, from USD42 per barrel in November 2013 to USD13.65 per barrel as of today.

That improvement came about in part because pipeline traffic eased somewhat, while producers found novel ways to get their energy products to market, including mostly crude by rail, but also crude by truck and barge among other modes.

Weakness in the Canadian dollar has also helped, with the exchange rate falling in sympathy with crude the past few weeks due to the perception that the loonie is a resource-backed currency.

Earlier this week, the exchange rate hit a five-year low of USD0.8852 and is only slightly up from that level at present. That’s a slide of nearly 6 percent from the currency’s interim high at the beginning of July.

In addition to the aforementioned narrowing differential, a weaker currency should provide some aid to producers’ bottom lines. Most commodities, including crude, are priced in US dollars when traded in the global marketplace, so that will give Canadian energy companies a modest bump when foreign sales are translated back into Canadian dollars.

Nevertheless, Canadian energy stocks have collectively fallen by nearly 20 percent in US dollar terms since their mid-June highs.

There are a number of factors weighing on oil prices, including weakening global demand coupled with uncertainty about near-term economic growth, as well as the glut of production from prolific US shale plays and Canadian oil sands.

The thing to remember is that we’ve been here before, as have most of the publicly traded energy producers whose shares have been punished these past few months. While the recent surge in unconventional production is a relatively new feature of the North American energy landscape, volatile commodity prices are not.

And since management teams have been bloodied by past boom-and-bust cycles, most attempt to mitigate at least some risk by hedging their production.

Although hedging programs typically involve the use of financial derivatives, these are not intended as speculative investments. Instead, the goal of these hedges is to set a ceiling and floor for a meaningful percentage of production.

The ceiling allows for some participation in crude’s upside during a bull run for the commodity, while the floor limits downside risk during an extended swoon. No company has a crystal ball, but at the very least this approach helps stabilize cash flows in the near to medium term, which not only smooths out earnings, but also enables management to more effectively allocate capital.

We reviewed the hedging programs of the five buy-rated crude oil producers in the Canadian Edge Portfolio.

All aim to pursue hedges that cover about 50 percent of production, with 45 percent to 68 percent of second-half crude production hedged as of the end of the second quarter. And some have already hedged a portion of their expected production in 2015.

WTI is the benchmark commodity for these hedging programs, and the average price per barrel is locked in around USD95 for the remainder of the year, which compares quite favorably to WTI’s recent price near USD83.

So how do oil company executives go about structuring their hedging programs? According to energy sector experts with the consultancy Deloitte, oil producers typically undertake a qualitative and quantitative risk assessment that examines their exposure to underlying commodity prices.

Then, companies will review historical pricing and other data and evaluate hedging strategies for various scenarios, including stress tests. Based on the results from such modeling, management can determine the appropriate level of hedging in accordance with their appetite for risk, along with meeting objectives such as greater clarity on near-term financial performance and managing analyst expectations.

In simpler terms, as Deloitte principal Paul Campbell put it, an oil producer might set its hedging goals by first asking, “What margin do I need per barrel of oil over the next five years to continue operations and meet my growth plans?”

With WTI trading near USD83, up from an intra-day low of USD79.78 on Oct. 16, in-place hedges could prove more critical than ever if oil continues to trade near these levels for the remainder of the fourth quarter. That’s because many Canadian oil projects have a breakeven point of around USD80 per barrel, according to economists with CIBC World Markets.