Hedging activity surged in this year's third quarter as oil producers rushed to lock in rising prices for future production, according to Wood Mackenzie's latest analysis of oil and gas hedging activity.
The analysis, which looked at 33 of the largest upstream companies with active hedging programs, found that companies added an annualized 897,000 b/d of new oil hedges during the third quarter, up 147% from second quarter. This was the highest volume of oil hedges added in a single quarter since WoodMac began tracking hedge additions in fourth-quarter 2015.
Most of the new derivatives were added at strike prices at $50-60/bbl. The recent increase in oil-price futures explains much of producers' eagerness to lock-in prices. Since the downturn began, producers have demonstrated more willingness to hedge while prices rise, but that only tells part of the story.
Andy McConn, WoodMac research analyst, said, "Many producers have been basing long-term growth targets on $50/bbl price scenarios. When futures prices rose above that level, producers may have viewed it as an opportunity to lock in prices that will enable them to hit—or maybe outperform—targets. Recent pressure from investors for producers to live within cash flow is likely compelling producers to limit exposure to price risk."
According to the analysis, Cenovus Energy Inc. and Hess Corp. added the most oil hedges, accounting for 35% of new volume added. But many other producers also hedged significant oil volumes, with 14 companies each adding at least 25,000 b/d.
"Oil prices have continued to rise after the third quarter. Producers that found $50-53/bbl [West Texas Intermediate] attractive may look to add more hedges at $53-59/bbl. But the recent surge in hedging leaves less room to add derivatives without exceeding historical levels," McConn said.
The peer group has 22% of 2018 liquids production hedged, whereas this time last year only 17% of 2017 liquids production was hedged.
"Hedge positions significantly influence tight-oil producers' decisions about budgets and activity. They are particularly pertinent at this stage of the year, when most companies are wrapping up the planning process for 2018," McConn said. "Producers that are able to lock in prices above previous expectations may feel more comfortable with increasing activity levels. Others may leave budgets unchanged and promote higher cash-flow guidance to an investment community anxious about profits."
The analysis also looked at gas-hedging activity, which was more subdued than oil. Gas hedges were down 29% from this year's second quarter, with only an annualized 1.6 bcfd of new gas hedges added during the third quarter. Most were added at strike prices between $3/Mcf and $3.40/Mcf at Henry Hub, with Range Resources Corp. accounting for 27% of new volume added.
"Gas-hedging activity has been much less volatile than oil during 2017, partially due to lower volatility in the underlying price of the commodity. Producers have demonstrated that—similar to oil—inflections in gas price can trigger inflections in hedging behaviour," McConn noted.