US producers add hedges to cushion cash flow

US independent producers took advantage of higher oil prices to lock in hedges in the second quarter as they sought to cushion their revenues from price swings.

Hedging plans have become a key focus for investors and shareholders as they seek to pressure companies to boost returns by shoring up their balance sheets and ensure clarity on their future revenues. The strategy is a balancing act as operators have to ensure they do not limit potential upsides in the event that the market rises. An increased focus on returns has not stopped output growth in the main US shale regions, but growth rates are slowing.

Occidental Petroleum has reaffirmed the central role of hedging by covering 40pc of its oil output for 2020 and 2021 as it deleverages from its $57bn Anadarko acquisition. The firm last hedged its output after acquiring Vintage Petroleum in 2006, chief financial officer Cedric Burgher says.

Many operators such as Pioneer Natural Resources — often among the most heavily hedged medium-to-large independent producers — bought new cover in the second quarter when crude prices were at the highest for the year, with Nymex WTI at $66/bl and Brent near $75/bl. Oil prices have fallen since then on signs that the global economy could be faltering. Analysts polled by Argusexpect benchmark North Sea Dated or Ice Brent futures to fall to nearly $65/bl next year. This puts prices at about $2/bl lower next year than this year. The EIA has forecast Brent prices at $65.15/bl this year and at $65/bl in 2020 in its most recent Short-Term Energy Outlook.

Pioneer is adding hedges "aggressively" to boost the return on capital employed, chief executive Scott Sheffield says. The company had hedged 72,000 b/d as of 2 August — a third of its production in the first half of this year — at a Brent price of about $67/bl for the remainder of this year. This compares with about a fifth of its 2019 output hedged as of 3 May. The company intends to hedge up to half of its production.

A floor in the plan

Bakken operator Whiting has hedged 59pc of its output for the rest of this year and 19pc for the first half of next. Smaller companies such as Laredo have been even more aggressive. Laredo has hedged about 95pc of its production at a weighted-average floor price of $60.42/bl for the rest of this year and three-quarters of next year's production at $58.79/bl. The company restructured its oil hedges for this year and next in the second quarter, closing out contracts that had a floor of about $47/bl. The change will net the company $60mn in additional cash flow this year.

Permian operator Parsley Energy added new Brent-linked hedges in the second quarter, taking total 2020 volumes under contract to a high of 56,000 b/d, up from 42,800 b/d of future output hedged as of the end of March.

Hedging strategies do entail risks for operators, as many of them discovered last year. Pioneer made a net derivative gain of $29mn in January-June, but a loss of $566mn in the same period a year earlier. Parsley made a gain of $19.6mn in the second quarter compared with a loss of $9.5mn a year earlier, but still made a loss overall during the first half of the year, of $100mn compared with a loss of $20.3mn a year earlier. QEP gained $54.5mn in the second quarter compared with a loss of $33.6mn a year earlier thanks in part to hedges. But it lost $121.3mn in the first half against a loss of $43.6mn a year earlier.

Despite the extra hedging activity by the independent oil companies, commercial short positions on the main WTI futures and options contracts tailed off after a surge in April.

WTI hedging and price