Production is expected to increase
West Texas Intermediate has continued to fall from its 2014 peak of $107.73 a barrel in June to $51.68 at 10:38 a.m. London time. That’s below the breakeven price for 37 of 38 U.S. shale oilfields, according to Bloomberg. Prices have dropped even further since then, sitting at $50.49 a barrel at the time of this story’s writing.
RBC Capital Markets and CIBC World Markets predict prices will remain below $60 for the first three months of 2015. Societe Generale SA’s Michael Wittner forecasts an average of $64.50 in Q1’15 and $61.50 in Q2’15, reports Bloomberg, continuing to keep pressure on U.S. shale producers.
Prices have remained low as Saudi Arabia maintains production targets in order to protect their market share. Despite being able to keep prices low, the Kingdom has not been able to prevent U.S. producers from continuing to increase output.
The U.S. Energy Information Administration (EIA) expects U.S. crude oil production in 2014 to grow from 2013 levels, and to continue growing in 2015. The EIA also expects that U.S. crude production will increase to 9.6 MMBOPD in 2019 from 6.5 MMBOPD in 2012, 22% higher than the administration’s predictions from last year.
Increased production may help some and harm others
With the EIA expecting that oil production will continue to grow, the global supply glut is only expected to remain. The collapse in oil prices gave consumers a break on gasoline prices and the cheapest heating oil costs in five years. Goldman Sachs Group Inc. analysts said last month that cheaper U.S. gasoline single-handedly will boost economic growth by 0.5% points this year.
“The benefit to consumers is a lot bigger than the hit to oil producers,” Mark Zandi, chief economist for Moody’s Analytics Inc. said to Bloomberg. “If we stay at $60 a barrel, consumers will save $150 billion on gasoline.”
Consumers are poised to benefit from lower fuel prices, but others are worried about the coming squeeze. Texas, in particular, looks like it could be hurt by the price slump.
Texas may be pushed into a “painful regional recession,” wrote Michael Feroli, chief U.S. economist at JPMorgan Chase & Co.. Texas is responsible for 34% of U.S. output, according to EIA data, with the oil and gas industry accounting for 11% of the state’s economy, according to Feroli.
Even as prices plummet, good hedging may help some producers through the lean times
Rather than wait for their price insurance to run out, many companies are cashing in on well-placed hedges to increase the number of future barrels hedged, according to industry consultants, bankers and analysts familiar with the deals, reports Reuters.
Currently, it is unclear which companies are trying to revamp their hedges since that information is not likely to be disclosed until quarterly earnings reports are released in late January, but many could use hedges to protect their operations longer than expected.
Many in OPEC had hoped that by keeping production steady, the market would force out higher cost shale production in the U.S. “There are companies which are hedged until the beginning of the year or until the end of the year, so we need to wait at least until the first quarter to see what is going to happen,” United Arab Emirates Energy Minister Suhail Bin Mohammed al-Mazroui said.
These comments were made on the basis of quarterly reports from several months ago, however. With prices showing no sign of climbing back up, some firms have put on new hedges that will help prevent their revenues from falling further. “OPEC should not expect to see any impact on U.S. shale growth in the first half of the year and the impact in the second half is being attenuated significantly by producer hedging,” says Ed Morse, global head of commodities research at Citigroup.
While the proportion of oil companies actually executing these deals is not that high, the deals thus far have been large in terms of volume and dollars, says Craig Breslau, who heads the energy derivatives marketing desk at Societe Generale in Houston, which has been involved in some restructuring transactions.
According to their last filings, oil companies such as EOG Resources Inc. (ticker: EOG), Anadarko Petroleum Corp. (ticker: APC), Devon Energy Corp. (ticker: DVN) and Noble Energy Inc. (ticker: NBL) had hedged some of their 2015 production at prices of $90 a barrel or more.
The net short position of oil producers and other non-financial companies in U.S. crude oil futures and options markets – used as a rough gauge of hedging activity – has grown to more than 77 MMBO last week from 15 MMBO in August.
For many companies that set up “in the money” hedges prior to the slump, the downturn offers a chance to cash in or extend their protection.
For example, a company that had sold swap contracts to hedge a part of its 2015 production at $90 a barrel – essentially shorting forward oil prices to guard against a drop – could buy them back now at around $57 for a profit of about $33 a barrel.
Some companies are using these profits in order to protect themselves against further market slide by buying swaps and options pegged closer to current market prices.
With December 2015 put option for $60 a barrel now trading at around $9 a barrel, swaps cashed in now could buy a producer nearly four times more protection at that price.
So far only two companies have publicly confirmed winding down their profitable hedge books.
Bakken shale oil producer Continental Resources (ticker: CLR) profited to the tune of $433 million by liquidating its hedges in September – a move that left the firm exposed to a further $20 slump, though it is not clear whether it has set up new hedges since.
On Tuesday, American Eagle Energy (ticker: AMZG) announced that it sold off its 414,000 barrels of oil hedged at $89.59 a barrel through last December for a profit of $13 million to improve its liquidity – even as the firm said it would have to stop drilling until prices improved.
Important disclosures: The information provided herein is believed to be reliable; however, EnerCom, Inc. makes no representation or warranty as to its completeness or accuracy. EnerCom’s conclusions are based upon information gathered from sources deemed to be reliable. This note is not intended as an offer or solicitation for the purchase or sale of any security or financial instrument of any company mentioned in this note. This note was prepared for general circulation and does not provide investment recommendations specific to individual investors. All readers of the note must make their own investment decisions based upon their specific investment objectives and financial situation utilizing their own financial advisors as they deem necessary. Investors should consider a company’s entire financial and operational structure in making any investment decisions. Past performance of any company discussed in this note should not be taken as an indication or guarantee of future results. EnerCom is a multi-disciplined management consulting services firm that regularly intends to seek business, or currently may be undertaking business, with companies covered on Oil & Gas 360®, and thereby seeks to receive compensation from these companies for its services. In addition, EnerCom, or its principals or employees, may have an economic interest in any of these companies. As a result, readers of EnerCom’s Oil & Gas 360® should be aware that the firm may have a conflict of interest that could affect the objectivity of this note. The company or companies covered in this note did not review the note prior to publication. EnerCom, or its principals or employees, may have an economic interest in any of the companies covered in this report or on Oil & Gas 360®. As a result, readers of EnerCom’s reports or Oil & Gas 360® should be aware that the firm may have a conflict of interest that could affect the objectivity of this report.
