Oil producers are taking advantage of the biggest monthly price increase since 2009 to sell more of their future output, threatening to slow the rally.
New York-traded crude for next-month delivery gained 25 percent in April on signs a record drop in drilling rigs is starting to reduce production, easing the biggest U.S. oil glut in 85 years. December 2016 contracts were up just 8.7 percent in that period.
Producers from Whiting Petroleum Corp. to WPX Energy Inc. are hedging more output to lock in sales at higher prices. An increase to $65 for an extended period may add an extra 500,000 barrels a day by the end of next year, according to Bloomberg Intelligence.
“Producers are hedging part of their future production,” said Bill O’Grady, chief market strategist at Confluence Investment Management in St. Louis, which oversees $3.4 billion. “Of course that activity has the effect of damping prices.”
WTI for June delivery fell 48 cents to $59.15 a barrel Friday on the New York Mercantile Exchange while the December 2016 contract lost 1 cent to $64.92. The gap between the two contracts has narrowed to $5.77 from $11.40 on March 18.
A flatter futures curve -- meaning a tightening of the price difference between the contracts -- suggests more hedging, which “could lock in some U.S. production for 2016 regardless of price,” Adam Longson, an analyst at Morgan Stanley, wrote in a report on April 20. It “may be an ominous sign for 2016” and “question the sustainability of any WTI rally,” he said.
Whiting Petroleum, the largest oil producer in North Dakota’s Bakken shale region, hedged 31 percent of 2016 estimated output as of April 23, up from 21 percent on Feb. 13, according to company filings and presentations. Hedging for this year was boosted to 38 percent from 18 percent.
Linn Energy LLC recently added 2015 oil hedges at $58 a barrel, increasing coverage to 80 percent of projected production from 70 percent in February.
“Prices have come up a decent amount,” Kolja Rockov, chief financial officer of Linn, said on an April 29 earnings call. “We felt comfortable stepping our oil hedges up for this year to lock in a better result than what we’ve previously forecasted.”
WPX Energy, a producer of shale oil and natural gas based in Tulsa, Oklahoma, hedged 7,000 barrels a day of 2016 production as of April 13, compared with nothing on Feb. 23.
Spokesmen for Linn Energy, Whiting Petroleum and WPX Energy didn’t immediately respond to telephone and e-mailed requests for comment.
Despite the rebound in oil, this may not be the best time for producers to lock in prices as crude will keep rising for the next year or two, said James Williams, an economist at WTRG Economics, an energy-research firm in London, Arkansas.
“Historically the futures curve is a poor forecaster of long-term prices,” Williams said. “If you go out two or three years, the odds are much better that oil prices will be higher than the futures curve indicates.”
U.S. drillers cut their oil rigs to 703 in the week ended April 24, the lowest level since 2010, according to Baker Hughes Inc.
The number of futures and options contracts that producers held to protect against a drop in WTI prices jumped 24 percent in the four weeks ended April 21 to the highest level since October 2011, according to the Commodity Futures Trading Commission.
“When prices get to these levels, there is more propensity to hedge,” said Michael Cohen, an analyst at Barclays Plc in New York. “In the $60 to $70 range, they want to lock in prices. We could see some further pressure from here.”