With oil hedges rolling off, U.S. shale producers face stiff test

NEW YORK (Reuters) - Cash-strapped U.S. shale oil producers are facing another sharp sell-off in a 18-month-old crude slump with reduced hedging protection, risking a severe hit to earnings if prices fail to recover.

An oil pumping machine is seen as non-usable gases are being burnt behind it in Sakir, south of Manama, October 11, 2014. REUTERS/Hamad I Mohammed

A Reuters analysis of hedging disclosures from the 30 largest oil producers showed the sector as a whole reduced its hedge books in the three months to September.

“Producers have survived 2015 as they benefited from large reductions in service costs while having a significant amount of production hedged at high prices,” said John Arnold, the Texas billionaire formerly at hedge fund Centaurus Advisors.

“Come Jan. 1, revenues will experience a pronounced decline for many companies, coinciding with a time of severe stress for balance sheets across the industry,” he told Reuters.

When oil started falling from around $100 a barrel in mid-2014 due to a global supply glut, many U.S. producers had strong hedge books guaranteeing prices around $90 a barrel.

Now, with prices below $36 and flirting with 11-year lows on renewed oversupply fears, only five drillers among those reviewed by Reuters expanded their hedges in the third quarter and eight had no protection beyond 2015, leaving them fully exposed to price swings. (Graphic:

The five companies that increased outstanding oil options, swaps or other derivative hedging positions to secure a price floor for their production, added 13 million barrels in the third quarter to 327 million barrels covered, data show.

Five other firms did not expand their books, with positions that either expire in 2016 or no hedges altogether.

The remaining 20 companies had hedges decline by 72 million barrels from the previous quarter.

Hedging disclosures serve as a leading indicator of drilling activity ahead and the expiry of positions points to a decline next year as low market prices offer little incentive for producers to ramp up programs.

While it is unclear how quickly the lack of hedges affects output, financial statements already show a significant hit to earnings.

Continental Resources, which made waves by selling its hedges last November when oil was around $80 per barrel, remains unhedged and while its third quarter output was up 25 percent from a year ago, crude and natural gas revenues fell 46 percent.

While crude prices tumbled more than 60 percent from mid-2014 peaks, the market offered brief opportunities to lock in better prices and companies that failed to capitalize on those are now most exposed.

One largely missed chance came when prices rallied to $60 a barrel in April. Another reprieve came in October when crude jumped more than 9 percent but hedging was, again, muted.

Among firms that bolstered hedges the most in the third quarter is EOG Resources, which added nearly 5 million barrels to its hedge books mainly in the form of put options with a $45 floor price. Even so, the company’s hedges do not go beyond 2015.

Devon Energy, Whiting Petroleum, Hess and Denbury Resources are among those that let the number of contracts fall the most. Devon and Hess are not hedged beyond 2015.

Producers contacted by Reuters declined to discuss their hedging strategies.


Hedges serve as an insurance, allowing producers to lock in prices at a set level; however, the cost of that insurance can rise as prices fall. That leaves some unprotected because of tight budgets, while others are willing to take a risk and bet that prices will recover next year.

“Clearly, the decision has been made on behalf of many of these companies not to hedge or to hold off for now,” said John Saucer, vice president of research and analysis at Mobius Risk Group.

Of the 30 analyzed companies, eight had no hedges going beyond 2015, including firms such as Devon, which let a large portion of hedges bought last year expire.

While its chief executive voiced confidence last quarter that Devon would be able to raise output despite hedges rolling off, the company said in a quarterly filing that low prices and expiry of its hedges this quarter would impact its earnings.

Cabot Oil and Gas, Hess and Apache were also unhedged beyond year end, though it was not clear if those companies bought any new hedges in the fourth quarter.

High-yield exploration companies have hedged only 35 percent of 2016 output by the third quarter, Citigroup said in a report, with the average price dropping by around $7 per barrel from the previous quarter.

With some highly-leveraged drillers possibly facing tough bi-annual credit negotiations with lenders in April, analysts say producers will need any relief they can get.

“Producers will have to look for targets to hedge when the market rallies,” said Michael Cohen, head of energy commodities research at Barclays. “The pain is going to worsen ahead and it’s going to be exacerbated by lower gas and (natural gas liquids) prices too.”

Reporting By Catherine Ngai; Editing by Jessica Resnick-Ault and Tomasz Janowski