US independents raise their hedges

US independent producers are stepping up hedging of oil and natural gas production as a safety net for stable cash flow, despite some losing money from derivatives in the second quarter.

US producers' hedging plans have increased slightly, with 52pc of their 2018 output covered compared with 49pc as of March, "even with oil futures above long-term management budgets of broadly $50-$55/bl," US bank Goldman Sachs says. Producers are hedging at an average price of $58/bl this year, below the $70/bl touched this week. "Hedging [for 2019] has remained around normal levels" of up to 23pc of oil production against 16pc in the first quarter.

Current hedged prices of $60/bl for 2019 are slightly below the forward price of $63/bl, which may add some restraint against increased drilling, the bank adds. The majority of production growth this year is coming from well-hedged firms, although this is less the case in 2019, the bank says.

The increase in 2018 hedged oil production comes despite some producers reporting losses from their hedging last quarter as a result of higher-than-expected crude prices. Pioneer Natural Resources, one of the most well-hedged onshore operators, made a non-cash mark-to-market derivative loss in April-June of $170mn because of the increase in Nymex oil prices, chief financial officer Richard Dealy says. This compares with a gain of $71mn a year earlier. Pioneer has kept its hedge book largely unchanged for the rest of this year and 2019, with about 85pc of its 2018 oil production covered. Whiting Petroleum made a non-cash loss of $50mn against a gain of $16mn in the second quarter of 2017. Whiting has marginally raised its hedging to 72pc from 70pc at the start of this year.

Hess has continued to hedge its 2019 and 2020 output to protect its cash flow, as the firm is in the middle of funding the large ExxonMobil-operated Guyana project. "When we get to the free cash flow phases of Guyana we will be in a different position, and hedging may fall as we move forward," Hess chief financial officer John Rielly says.

An unintended consequence of hedging losses is increased capital discipline, Goldman Sachs says. Investors have pressured independents to manage their budgets within cash flows as the industry's share performance has lagged rises in crude prices and broader financial markets. A lack of gains from oil market upside is making the industry execute plans at a WTI price of $50-$60/bl, the bank says.

Peer pressure

An exception is Continental Resources, which removed all its oil hedges in 2014 on a prediction that the crude price slump was temporary. The firm was exposed to the price collapse in 2015 and 2016 but is now benefiting from the recovery. "We appear to be the only unhedged oil producer in our peer group able to fully participate in the higher oil prices today," chief executive Harold Hamm says.

Permian producers are also taking on hedges to protect the difference between the region's crude prices and benchmark WTI. Prices in the basin are under pressure because of pipeline constraintslimiting oil exports from the region. Large producers have about 60pc of their Permian oil output in 2019 "protected against a basis blowout", US bank Tudor Pickering Holt says, while small and mid-sized independents have about 45pc.

Apache is currently exposed to Midland basis price movements for just under 60pc of its 2018 oil output, which will increase by another 10pc next year if it does not take any further hedges later, chief financial officer Stephen Riney says. Energen, which is being acquired by Diamondback, took on differential hedges out to 2020 in the second quarter in case supply bottlenecks do not alleviate until then. "We thought it prudent to go ahead and take a decent hedge position," chief executive James McManus says.