Scrambling for cover, U.S. shale producers ramp up hedging
Struggling U.S. shale producers have scrambled to sell future output at their fastest pace in about six months in recent weeks, curbing a rebound in prices and potentially prolonging the oil market’s worst rout in a generation, traders say.
As spot prices of crude CLc1 rallied almost 60 percent from 12-year lows touched in mid-Feb, turnover in the long-dated oil contracts has soared to record highs, as producers started to lock in prices in the $40s, traders have said.
Turnover in the U.S. crude contracts for December 2017 CLZ7 surged to record highs of over 30,000 lots this past Friday while volumes in the December 2016 CLZ6 delivery touched an all-time high of nearly 94,000 lots.
Combined, that equates to almost 125 million barrels of oil worth over $5 billion, a small portion of overall daily volume in U.S. crude futures, but enough to catch traders’ attention.
One broker transacting deals for producers said it was the busiest he has been since October.
The hedging interest re-emerged in early February, but was limited to inquiries.
Now, brokers and traders say that has turned into execution, with some producers willing to hedge in the high $30s or low $40s in 2016 and between $45-50 next year, levels that are just about breakeven for many.
That is also below the $50 psychological threshold that many had thought would be necessary to prompt producers to seek price protection, suggesting drillers have accepted a new reality of lower-for-longer prices as OPEC pumps out record volumes and Iran’s exports flood an already saturated market.
“Those that didn’t take advantage of hedging in the past are likely more inclined to do it now, because the longevity of their business depends on it,” said Tony Headrick, an energy market analyst at CHS Hedging LLC.
“The cost of production has declined to the point where at mid-40s they can hedge actively to remain viable.”
Piling on hedges could prevent prices rallying through $45 a barrel while the extra protection may delay further U.S. production cuts, seen as key to eroding the glut that has pushed prices down 75 percent over 20 months, experts said. (Full Story)
In addition to output, hedging allows cash-strapped producers to also boost cash flow, critical to their survival.
HOPING FOR PROLONGED PROTECTION
The impact of the pickup in hedging activity was most conspicuous in longer dated oil contracts.
The 2017 WTI price strip CLCALYZ7 has risen only about 15 percent over the past six weeks, much lower than the prompt contract’s gains, while the selling has almost erased the far forward contract’s premium over spot CLc1-CLc25.
The contango, as the structure is known, narrowed to $5.82 on Monday, its lowest in almost nine months, and down nearly two thirds from about a month ago.
John Saucer, vice president of research and analysis at Mobius Risk Group in Houston, said he saw a “material” increase in producer hedging, with most action in this and next year’s contracts, but extending through the whole of 2018.
Lack of forward buying by major consumers, like the airlines, has also meant prices have not received any boost as producers have been selling, adding to the pressure on prices. (Full Story)
Other factors have also contributed to the flattening curve, including short covering in the front month and output declines in the U.S.
DISTRESSED VS HOLDOUTS
To be sure, many hope for prices to go even higher.
“If prices recovered to that range north of $60, we’ll be seriously considering hedging,” billionaire wildcatter Harold Hamm, who runs Continental Resources Inc CLR.N, said on a conference call late February.
Sources said that many of the hedges in recent weeks have been banks mandating hedges for the next 18-24 months to put a floor on asset values.
Morgan Stanley said in a note it has also seen “healthy” appetite for hedging from mid- and large-cap Permian producers, citing anecdotal evidence from the bank’s trading desk.
In another sign of the prevalent hedging, net short positions among producers and consumers have jumped to record highs in recent weeks, data from the U.S. Commodity Futures Trading Commission (CFTC) shows.