Revamped U.S. Oil Hedges May Test OPEC's Patience
As a war of nerves between U.S. shale producers and Gulf powerhouses intensifies, OPEC's biggest members are counting down the months until their upstart rivals lose the one thing shielding them from crashing oil prices – hedges.
They may need much more patience than they reckon, however, because those hedges are a moving target. Rather than wait for their price insurance to run out, many companies are racing to revamp their policies, cashing in well-placed hedges to increase the number of future barrels hedged, according to industry consultants, bankers and analysts familiar with the deals.
OPEC officials hope that once U.S. oil companies get fully exposed to the impact of an over 50 percent slide in crude prices since last June, they will have to drill fewer new wells, causing U.S. production growth to stall and putting a floor under oil prices now testing $50 a barrel.
“There are companies which are hedged until the beginning of the year or until the end of the year, so we need to wait at least until the first quarter to see what is going to happen,” United Arab Emirates Energy Minister Suhail Bin Mohammed al-Mazroui told Reuters and one other news agency last month.
Yet that hope is based largely on quarterly company reports from several months ago, when drillers last made their hedging portfolios public. In the meantime, with the price rout showing no sign of reversing, at least some firms have put on new hedges that will help prevent their revenues from falling further – and allow them to drill far longer this year than earlier expected.
“OPEC should not expect to see any impact on U.S. shale growth in the first half of the year and the impact in the second half is being attenuated significantly by producer hedging,” says Ed Morse, global head of commodities research at Citigroup, one of the biggest U.S. banks involved hedging.
CAPTURING THE UPSIDE
For the moment, it is unclear which companies are involved in the effort. New hedging strategies are only likely to get disclosed in quarterly earnings reports in late January.
“It's a hot topic of discussion that everyone is thinking about and looking at,” said Craig Breslau, who heads the energy derivatives marketing desk at Societe Generale in Houston, which has been involved in some restructuring transactions.
While the proportion of oil companies actually executing those deals is not that high, the deals thus far have been large in terms of volume and dollars, he said.
According to their last filings, oil companies such as EOG Resources Inc, Anadarko Petroleum Corp, Devon Energy Corp and Noble Energy Inc had hedged some of their 2015 production at prices of $90 a barrel or more.
The net short position of oil producers and other non-financial companies in U.S. crude oil futures and options markets — used as a rough gauge of hedging activity — has grown from 15 million barrels in August to more than 77 million barrels last week.
For many companies that set up “in the money” hedges prior to the slump, the downturn offers a chance to cash in or extend their protection.
For example, a company that had sold swap contracts to hedge a part of its 2015 production at $90 a barrel – essentially shorting forward oil prices to guard against a drop – could buy them now back at around $57 for a profit of about $33 a barrel.
Instead of just pocketing the cash, some companies are using the funds to shield themselves against a further market slide by buying swaps and options pegged closer to current prices.
With the December 2015 put option for $60 a barrel now trading at around $9 a barrel, swaps cashed in now could buy a producer nearly four times more protection at that price.
PROFITS OR SURVIVAL
Most of the half-dozen companies contacted by Reuters – those with sizeable hedges in place – declined to comment or did not reply to requests for comment.
A spokeswoman for EOG said that it was not selling off its hedges. Devon Energy declined to say whether the company was restructuring is large hedge book, but said it had not 'monetized' any of its position.
So far only two companies have publicly confirmed winding down their profitable hedge books.
Bakken shale oil pioneer Continental Resources pocketed $433 million by liquidating its hedges in September – a move that left the firm exposed to a further $20 slump, though it is not clear whether it has set up new hedges since.
On Tuesday, tiny firm American Eagle Energy announced that it sold off its 414,000 barrels of oil hedged at $89.59 a barrel through last December for a profit of $13 million to improve its liquidity – even as the firm said it would have to stop drilling until prices improved.
That appears to be the effect that OPEC is looking for, although thus far it is the exception rather than the rule.
“The companies' situation is strong,” said an OPEC delegate from a Gulf producer. “All this will delay the impact of the lower oil prices.”