Surge in oil hedging could worsen U.S. supply glut, Wood Mac says


HOUSTON, LONDON and SINGAPORE -- Wood Mackenzie's latest analysis of oil and gas hedging activity shows a recent surge in oil hedges.

Those hoping that recent oil-price weakness will prompt U.S. producers to pull back drilling activity and ease the glut of oil supply may need to keep waiting.

Andy McConn, research analyst at Wood Mackenzie, explains why recent hedging activity will keep drilling levels buoyant during periods of low oil prices: "Recent disclosures reveal that producers rushed to lock in oil prices above $50/bbl after OPEC's November announcement about production cuts. Our peer group of producers added a higher volume of oil hedges during fourth-quarter than in any of the previous four quarters. Those producers – most of which are highly exposed to U.S. tight oil – will use hedging gains to help plug any budget deficits caused by sub-$50 spot prices."

But 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," says McConn.

Hedging activity surged for oil, but plummeted for gas

Source: Wood Mackenzie.

Oil. The latest oil hedging activity in Wood Mackenzie's analysis of companies, comprising a group of 33 of the largest upstream companies with active hedging programs, shows that companies added 648,000 bpd of new oil hedges since fourth-quarter 2016, which is an increase of 33% from third-quarter 2016. 

Most of the new oil derivatives were added at strike prices between $50 and $60/bbl. 

Apache and Anadarko added the most oil hedges, accounting for 28% of all new volume added. 

Gas. According to Wood Mackenzie's analysis of hedging activity during fourth-quarter 2016, gas hedging activity was more subdued, mainly because producers already held healthy positions for 2017.

The analysis shows 2.2 Bcfgd of new gas hedges were added during fourth-quarter 2016, down 57% from third-quarter 2016.

Most of the new gas derivatives were added at strike prices between $3.00/mcf and $3.60/mcf Henry Hub.

Oil hedge activity

"Hedge price disparities are due to price volatility, contract structures and hedge dates," explains McConn.

"Predictably, the biggest gas players accounted for most activity: Southwestern, Encana, Range and Chesapeake accounted for 62% of new volumes added."

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

"The outlook for hedging activity seems poised to plateau or decline," says McConn. 

"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 versus 32% and 28% in 2016. 

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


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