The Fuse

Hedging Provides Lifeline to Shale Producers Ahead of OPEC Uncertainty

by Matt Piotrowski | April 04, 2017

“[Shale] companies have to keep costs down and manage their cash flow. But in the end, how well production performs and how well these companies perform is macro-driven.”

Stabilizing the balance sheet, slashing costs, hedging as an insurance policy, improving efficiency, and reducing debt…all of these measures have played a critical role in allowing U.S. shale producers to increase production, which has in turn kept a lid on oil prices. As company officials made their cases to Wall Street analysts, money managers, and other investors at both days of the Independent Petroleum Association of America’s (IPAA) Oil & Gas Investment Symposium (OGIS) in New York this week, they focused on their plans going forward and emphasized individual improvements in their capital budgets. But there was little talk about the direction of oil prices. Why is that? One investment bank analyst told The Fuse at the event that companies, like all market watchers, remain highly uncertain about where oil prices are going.

“These companies have to keep costs down and manage their cash flow,” the analyst said. “But in the end, how well production performs and how well these companies perform is macro-driven.”

Jarand Rystad, Founder and Managing Parter of Rystad Energy, told the conference on Monday that a surge in production could lead to a price collapse. A repeat of oil prices falling to below $30, as they did in early 2016 as a result of high U.S. output and elevated OPEC production levels, is the last thing these companies want after they have repaired their balance sheets and cut their debt.

Stability through hedging

One way to deal with a potential oil price plunge is through aggressive hedging, which a number of companies are in fact doing in an effort to reduce exposure to volatility. An official from Whiting Petroleum, which cut debt by 42 percent in the past year, told attendees at OGIS that it has hedged 53 percent of its production for 2017, while an executive from Pioneer Natural Resources touted its hedging strategy saying the company has put $2.6 billion into hedges in the last seven years. The official presenting from Carrizo Oil & Gas noted that his company has been hesitant, so far, on hedging at a large amount for the second half of this year because of uncertainty around the OPEC cut and cost inflation, but current price levels are high enough to add more hedges for the rest of 2017. SM Energy said it has hedged a whopping 80 percent of oil and gas output for 2017, while also locking in about a third of production for 2018.

One way to deal with a potential oil price plunge is through aggressive hedging, which a number of companies are in fact doing in an effort to reduce exposure to price volatility.

Tim Dove, the President and CEO of Pioneer, said that his company will hedge more when prices rise above $55 per barrel and “hoard cash” so it can operate with increased flexibility when the market dips below that level.

While Pioneer is well hedged to deal with any downturns in the short run, it is also planning for the long term. Unlike its independent peers, the company has announced an ambitious long-term plan, to boost production by about 15 percent per year to reach 1 million barrels per day in 10 years. A number of analysts and investors are, of course, skeptical of this strategy, which Dove addressed in his presentation. “The oil is not in question,” he said, noting that the economics of production will be the issue. Dove argued that for the next three years the company already has wells ready to operate to meet its goals. For years four through ten of the plan, Pioneer will rely on greater efficiencies and technological advancements to help it reach its ambitions—using just 40 rigs to produce 1 mbd. The company has the manpower and asset base to increase output over the longer term, Dove said, and it plans to use artificial intelligence and predictive analytics to save costs and improve operations. The strategy is for a “consistent growth rate” and “not to just respond to price signals.”

Pioneer plans to boost production by about 15 percent per year to reach 1 mbd in 10 years.

Pioneer is a big player in the Permian Basin, and sees its production growing by 30-34 percent there this year. The company will also move back to the Eagle Ford where it will take a “Permian-style” approach with longer laterals and higher-density completions. Like others, Pioneer has a number of drilled but uncompleted wells (DUCs) that it plans to bring online this year. These DUCs will provide a major source of production growth for companies and the industry as a whole—which have the power to cap prices, or cause the price downturn that a number are expecting. The EIA is expecting U.S. output to reach 9.44 mbd in the fourth quarter, up some 800,000 b/d from Q3 of last year, offsetting some two-thirds of OPEC’s 1.2 mbd cut.

Even with the positive outlook for the rest of the year, and beyond for some companies, a lot hinges on OPEC’s decision next month and the effectiveness of the supply curbs if the cartel rolls over.

Even with the positive outlook for the rest of the year, and beyond for some companies, a lot hinges on OPEC’s decision next month and the effectiveness of the supply curbs if the cartel rolls over. The growing consensus is that the Saudis, and by extension OPEC, will restrain supply long enough to push prices to $60 for the Aramco IPO. But that would bring about an enormous amount of risks for everyone in the oil sector as the situation would stimulate a large amount of supply, in both OPEC and non-OPEC producers. “If the Saudis get the price level they want and open up Aramco, the entire market dynamic will likely change. And then prices could collapse again,” the investment bank analyst told The Fuse.

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