Producers double down on hedging in Q3 2017

Hedging activity surged in Q3 2017 as oil producers rushed to lock in rising prices for future production, according to Wood Mackenzie's latest analysis of oil and gas hedging activity.

The analysis, which looks at 33 of the largest upstream companies with active hedging programmes, found that companies added 897,000 barrels a day (annualised) of new oil hedges during Q3 2017, up 147% from Q2 2017. This was the highest volume of oil hedges added in a single quarter since Wood Mackenzie began tracking hedge additions in Q4 2015.

Most of the new derivatives were added at strike prices between US$50-$60 a barrel.  The recent increase in oil-price futures explains much of producers' eagerness to lock in prices. Since the downturn began producers have demonstrated more willingness to hedge while prices rise, but that only tells part of the story.

Andy McConn, research analyst at Wood Mackenzie, explains: "Many producers have been basing long-term growth targets on ~US$50-a-barrel price scenarios. When futures prices rose above that level, producers may have viewed it as an opportunity to lock in prices that will enable them to hit – or maybe outperform – targets. Recent pressure from investors for producers to live within cash flow is likely compelling producers to limit exposure to price risk."

According to the analysis, Cenovus and Hess added the most oil hedges, accounting for 35% of new volume added. But many other producers also hedged significant oil volumes, with 14 companies each adding at least 25,000 barrels a day.

"Oil prices have continued to rise after Q3. Producers that found US$50-53/bbl WTI attractive may look to add more hedges at US$53-59/bbl. But the recent surge in hedging leaves less room to add derivatives without exceeding historical levels." said McConn.

The peer group has 22% of 2018 liquids production hedged, whereas this time last year, only 17% of 2017 liquids production was hedged.

"Hedge positions significantly influence tight-oil producers' decisions about budgets and activity. They are particularly pertinent at this stage of the year, when most companies are wrapping up the planning process for 2018," noted Mr. McConn. "Producers that are able to lock in prices above previous expectations may feel more comfortable with increasing activity levels. Others may leave budgets unchanged and promote higher cash-flow guidance to an investment community anxious about profits."

The analysis also looked at gas-hedging activity, which was more subdued than oil. Gas hedges were down 29% from Q2 2017, with only 1.6 billion cubic feet  a day (annualised) of new gas hedges added during Q3 2017. Most were added at strike prices between US$3.00/mcf and US$3.40/mcf Henry Hub, with Range Resources accounting for 27% of new volume added.

"Gas-hedging activity has been much less volatile than oil during 2017, partially due to lower volatility in the underlying price of the commodity. Producers have demonstrated that – similar to oil – inflections in gas price can trigger inflections in hedging behaviour," said McConn.