U.S. SHALE OIL: HEDGED & UNHEDGED
Oil's slide to the lowest price in more than five years is carving a divide between U.S. shale drillers who heavily hedged future production and those who didn't.
While financial hedges are commonly required by many oilfield lenders, the industry's mid-sized U.S.-focused shale field producers pursued varied strategies when it came to protecting future revenues, according to a Reuters review of filings and interviews with bankers and experts.
Those decisions are now coming back to haunt some drillers. Best-known is Continental Resources, which lifted its hedges in early November, when oil was trading at around $83 a barrel, leaving it unprotected as prices slipped another $20, the most dramatic drop since the 2008 crisis. Continental's share price has been more than halved since late June.
Apache Corp and Whiting Petroleum are also exposed to lower prices and have underperformed some peers over the past two weeks.
Oil producers typically hedge against lower prices by locking in some of their future production at favorable prices through swap transactions sold by banks, or by buying options as insurance against lower prices.
Among major and mid-sized exploration and production companies, some 35 percent of all 2014 oil production was hedged at an average of $95.5 a barrel as of November, according to an analysis prepared by RBC. Yet only 14.3 percent of 2015 production was hedged.
With OPEC kingpin Saudi Arabia refusing to cut supply and shore up prices any time soon, firms face the prospect of lower revenues for months to come. U.S. crude fell below $60 a barrel on Thursday for the first time since 2009.
At Devon Energy Corp, the effect of tumbling prices "may not be nearly as large as you think" because of hedging, said Dave Hager, Devon's chief operating officer, at the CapitalOne Energy Conference on Wednesday. "We're in outstanding shape as a company."
Devon, which pumped over 80 percent of its oil from U.S. shale fields last quarter, stands out as the most aggressive hedger among the larger-cap U.S. oil drillers. It has hedged about 140,000 barrels per day (bpd) of crude for all of next year, equivalent to 80 percent of its third quarter output, according to company filings.
If U.S. crude prices were to remain at about $65 a barrel next year, those hedges could net Devon an extra $1.3 billion in revenue, according to Reuters calculations.
Devon has been "very good at not drinking the Kool-Aid" in an industry that had been counting on years of high prices, said Rick Rule, chairman of Sprott US Holdings, an asset management firm that doesn't own stock in Devon.
For the past several years, hedging was a relatively minor consideration for investors. Oil prices stayed fairly steady at about $100 a barrel, meaning most hedged positions were neither heavily in nor out of the money.
Now that the crude price has almost halved in the past six months, and predictions grow for a prolonged slump in prices, investors are scrutinizing filings to understand which corporations were clever enough to have locked in prices prior to the slump and therefore have enough cash on hand to pay increasingly expensive service contracts.
"The purpose of hedging is to secure cash flow regardless of price scenario," said Robert Campbell, head of oil products research at Energy Aspects in New York. "The whole thing with (shale drillers) is cash preservation."
Most large-cap producers, unlike Devon, don't hedge as a rule, and many such as Occidental Petroleum and ConocoPhilips have even outperformed Oklahoma City-based Devon in recent months, aided in part by their refinery holdings, which generate additional revenue when oil prices are down.
Some analysts point to Apache as an example of the perils of not hedging. While Devon's shares have fallen by 32 percent since June, Apache's have dropped by 44 percent as investors raise alarms about a potential cash crunch.
"They're basically naked and don't have any cash flow protection," said Leo Mariani, a senior analyst at Capital Markets.
While hedging helps producers stem losses when prices are low, it also caps their potential gains. Many lenders require their clients to place some hedges on future production in order to smooth out revenue volatility.
But others have much more flexibility.
Whiting Petroleum, which like its peer and rival Continental is heavily focused on the Bakken shale fields in North Dakota, had hedged only about 3,000 bpd in 2015, according to the firm's third-quarter SEC filings, or about four percent of its current daily production.
Its acquisition of Kodiak Energy Inc, expected to close early next year, will add another 6,000 barrels a day of hedged production through 2015, a spokesman said - still only 7 percent of the combined company's output at current levels.
That may explain why Whiting's stock has fallen almost 65 percent from all-time highs in late August, though the pending acquisition and its exposure to the higher-cost Bakken play are also likely considerations.
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