WoodMac: Surge in oil hedging could worsen US supply glut

Due to a surge in oil hedges, the recent oil-price weakness will not prompt US producers to pull back on drilling, research and consulting firm Wood Mackenzie Ltd. says in its latest analysis of oil and gas hedging activity.

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Due to a surge in oil hedges, the recent oil-price weakness will not prompt US producers to pull back on drilling, research and consulting firm Wood Mackenzie Ltd. says in its latest analysis of oil and gas hedging activity.

“Recent disclosures reveal that producers rushed to lock in oil prices above $50/bbl after [the Organization of Petroleum Exporting Countries’] November announcement about production cuts. Our peer group of producers added a higher volume of oil hedges during 2016 fourth quarter than in any of the previous four quarters. Those producers—most of which are highly exposed to US tight oil—will use hedging gains to help plug any budget deficits caused by sub-$50[/bbl] spot prices,” said Andy McConn, research analyst at WoodMac.

However, hedging’s effect on oil-supply fundamentals should not be overstated. “Most of the hedges expire by 2018. Oil futures prices must recover before producers can lock in prices over $55/bbl for next year, which is what we think is needed to organically fund significant tight-oil production growth,” McConn said.

Oil, gas hedge activity

According to WoodMac’s analysis of hedging activity in last year’s fourth quarter, hedging activity surged for oil, but plummeted for gas.

The latest oil hedging activity in WoodMac’s analysis of companies, comprising a group of 33 of the largest upstream companies with active hedging programs, shows that companies added 648,000 b/d (annualized) of new oil hedges since fourth-quarter 2016, which is an increase of 33% from last year’s third quarter.

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Most of the new oil derivatives were added at strike prices between $50/bbl and $60/bbl. Apache Corp. and Anadarko Petroleum Corp. added the most oil hedges, accounting for 28% of all new volume added.

On the contrary, gas hedging activity was more subdued, mainly because producers already held healthy positions for this year.

The analysis shows 2.2 bcfd of new gas hedges were added in fourth quarter 2016, which was down 57% from third-quarter 2016. Most of the new gas derivatives were added at Henry Hub strike prices between $3/Mcf and $3.60/Mcf.

“Hedge price disparities are due to price volatility, contract structures, and hedge dates,” McConn said. “Predictably, the biggest gas players accounted for most activity: Southwestern [Energy], Encana [Corp.], Range [Resources Corp.], and Chesapeake [Energy Corp.] accounted for 62% of new volumes added.”

Simpler swap contract styles are slowly returning to popularity, accounting for 38% of new derivatives—vs. 25% in last year’s third quarter but still below the 42% and 66% proportions during the second and the first quarter of 2016, respectively.

“The outlook for hedging activity seems poised to plateau or decline,” McConn explained. “At this early stage of the year, the peer group already has a higher proportion of its liquids production hedged than the prior two years with 26% in 2017 versus 24% and 23% in 2016 and 2015, respectively. The same is true for gas with 42% in 2017 vs. 32% and 28% in 2016.”

McConn said, “As companies consider adding new hedges, OPEC comments and plans are likely to play a larger-than-usual factor.”

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