Shale producers’ hedging strategies take center stage

US upstream independents' hedging strategies for this year and next are getting unprecedented attention as investors sieve through firms to find those best placed to weather continued market volatility with cash flows cushioned by derivatives.

Hedging positions have become a key differentiator in determining operational plans since shale producers accelerated the shut-in of wells after front-month WTI futures prices briefly turned negative in April. Key Permian operators Pioneer Natural Resources, Diamondback Energy, Parsley Energy and Concho Resources have over 85pc of their 2020 output hedged, with the largest rise in hedges during the first quarter coming from the first three, US bank Goldman Sachs says.

Overall, producers' oil hedges have reached 66pc of their estimated output for this year — the highest in at least five years, up from 48pc before the oil price crash began in early March, Goldman Sachs says. About 60pc of that rise reflects an increase in hedging positions, while the rest comes from a drop in production from well shut-ins and reduced drilling. Operators have expanded their cover for 2021 as well, to 14pc, from 2pc at the end of last year, putting it slightly above average, the bank says. The average oil price hedge for this year is $44.19/bl, well above the current futures market. Gas hedging, at 47pc of output, is at an average of $2.66/mn Btu — higher than the current forward market of just over $2/mn Btu.

Concho has $54/bl hedges for WTI and Brent covering slightly over 150,000 b/d for the rest of the year, having produced 209,000 b/d in the first quarter. It is among the independents to have announced minimal shut-ins following the crude price collapse. US energy investment bank Tudor Pickering Holt (TPH) expects Concho to produce 200,000 b/d this year on slightly lower-than-targeted capital expenditures of $1.6bn, and to generate $950mn of pre-dividend free cash flow, in part driven by its hedges. The firm made a first-quarter derivative gain of $1.8bn versus a $1bn loss a year earlier, and TPH sees the combination of a strong hedge book and strong balance sheet equipping it to handle the market downturn well.

Pioneer, which made a net derivative gain of $453mn in the first quarter compared with a loss of $13mn a year earlier, took on fresh cover for 2021, of 135,000 b/d at $43/bl Brent, with protected upside. Parsley, which gained $546mn from derivatives in January-March against a loss of $120mn a year earlier, updated its hedging strategy for this year and next in March, when the price downturn began. It sees net settlement gains of $300mn-400mn over this year and next. Diamondback, which made a first-quarter derivative gain of $542mn versus a loss of $268mn a year earlier, had its entire 2020 output and half of 2021 volumes covered as of the end of March. Hess has more than 80pc of its 2020 oil output hedged, at $55/bl WTI for 130,000 b/d and $60/bl Brent for 20,000 b/d.

Living life on the hedge

This year's unprecedented price downturn has even prompted some producers that typically refrain from hedging to take on protection. Apache, which did not have any hedges in 2019 or at the start of this year, has purchased cover because "oil prices are getting into range where costs just can't be cut low enough to maintain free cash flow", chief financial officer Steve Riney says. It has hedged the bulk of its expected second-quarter output, with successively smaller volumes for the third and fourth quarters. "We knew the second quarter was going to be very, very painful," Riney says. As a diversified operator, Apache has "some natural hedges already in the portfolio", he says.

Occidental Petroleum, another diversified independent that does not normally use derivatives but took them on last year following its $57bn purchase of Anadarko, made a $1bn gain on its position in the first quarter.

By Manash Goswami