Over the last several months, oil price volatility increased, oil prices collapsed, and now prices are back on the rise. One way that E&Ps can combat downside price risk is to enter into hedging contracts on future production to lock either a specific price or a range of ‘acceptable’ price volatility. Throughout the first three quarters of 2018, oil prices were on the rise. Additionally, some forecasters were calling for even higher prices in 2019. However, the 2019 forward curve for crude oil remained in backwardation. As a result, many E&Ps hedged far less future production than they had in previous years. The resulting steady decline in crude prices to end 2018 caught many E&Ps off guard and leaves the market wondering who is least equipped if price weakness continues in 2019 and who might add the most hedges once 4Q filings are released.
In general, E&Ps consistently build out their hedges for the next year throughout the calendar year. However, the majority of next year’s oil hedging activity occurs in the third and fourth quarters. Typically driven by a combination of improved liquidity in futures contracts and budget planning. However, an increase in hedged oil volumes did not surface in 3Q18 due to concerns of supply shortages. Iranian sanctions and pipeline bottlenecks, likely left producers more willing to accept market volatility. Particularly, when to that point in 2018, volatility had only sent WTI prices higher. As an example, Continental Resources (NYSE: CLR) reiterated on earnings calls the willingness to accept full price risk. Therefore, CLR would not hedge due to low-cost production and expectation of higher crude prices. Continental was not alone in that expectation or willingness to take on risk for 2019.
The chart below shows the percentage of expected 2018 and 2019 oil production that 22 oil-focused E&Ps had hedged as of 3Q17 and 3Q18, respectively. The data below illustrates how different operators’ thoughts around oil hedging may have changed over the past year. Of the 22 operators shown, half have significantly fewer hedges in place for 2019 production. In order to match 3Q2017 oil hedging, the selected operators would have to add 140 Mb/d of oil hedges. Chesapeake Energy (NYSE: CHK) announced additional 2019 crude hedges on January 8. The increase though only results in ~40% of expected 2019 oil production being hedged. Much less than the 55% of expected 2018 production hedged at the same point last year.
Just as important as the volume of production hedged is the price at which they are hedging. While many E&Ps highlight their low-cost production base, in a $50 WTI price environment many of them have locked in price protection. The chart below shows the average premium to WTI that each E&P could realize in 2019 given a market price of $50/bbl. This data does not include the effects of hedges on international production or basis hedges. Of the 22 operators, eight could realize a premium of $3 or more to WTI in 2019. While many large operators elect to take on price risk, some smaller operators have done the same, including Carrizo, Newfield and Whiting.
Over the next few weeks, operators will be announcing updated oil hedging positions for 2019. BTU Analytics will monitor closely which companies added on natural gas and oil hedges in 4Q18. BTU Analytics expects crude prices to remain volatile in 2019 as data surrounding global crude demand and OPEC+ production cuts surface. With producers currently less hedged and much more focused on returning cash flow to shareholders than in past years, falling crude prices could have a much greater impact on US production. To see our forecasts for crude prices throughout 2019 as well as other factors and analysis on North American production growth, request a sample of our Oil Market Outlook and Upstream Outlook reports.