Oil producers locking in price gains from Middle East tension

By Catherine Ngai on 1/7/2020

NEW YORK (Bloomberg) - U.S. oil producers are taking advantage of the rally following the killing of a top Iranian general to lock in prices for more of their 2020 and 2021 output.

The hedging may extend a lifeline to producers, allowing them to maintain higher output at a time when analysts are expecting growth to slow. That potentially undercuts calls for a slow winding down of the shale boom, driven by a combination of firms buckling under investor demands for capital discipline, lower forward prices and engineering issues.

Producers operating in some of the largest U.S. shale basins have added hedges since Friday, according to people familiar with the trades. The firms used a combination of options strategies, including spreads and collars, to lock in the highest selling prices in months as oil pushed above $70 a barrel in London for the first time since September.

The 13 largest producers tracked by BloombergNEF had hedged an average of 13% of their 2020 output as of Sept. 30, analysts said in a note last month. Half of the 12 largest had no hedges in place.

The Energy Information Administration said in December that U.S. 2020 oil production will grow by 930,000 barrels a day this year, down from the 1 million barrels in its previous forecast.

The average price for U.S. crude for all of 2020 closed above $60 a barrel on Friday, the highest level since May 2019. Many firms missed the September rally, as prices quickly came back down following a quick spike after unprecedented attacks on Saudi Arabia’s oil infrastructure.

A number of large trades in the financial options market were booked on Friday, notably some average-price options in the form of three-way collars on the New York Mercantile Exchange for 2020 and 2021, according to data compiled by Bloomberg. Those strategies involve a producer buying put spreads -- which offer protection against a drop in prices -- while selling calls to offset the cost of the insurance. That will limit how much additional profit the producer can make if prices continue higher.

It’s not just U.S. companies that have been using the recent price rally to increase their hedging levels, as those in the North Sea have also been active, traders said. Brent for 2020 has rallied toward $65 since the start of the year, enabling producers to potentially lock in the highest prices in almost eight months.

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