Shale Oil Firms Hedge 2017 Prices in ‘Droves’ on OPEC Rally

  • Morgan Stanley says hedging may be highest so far this year
  • OPEC effectively threw ‘lifeline’ to shale producers, BNP says

Will the OPEC Deal to Cut Production Hold?

Independent oil companies are using the post-OPEC rally to hedge their price risk for next year, banks and consultants said, a trend that’s likely to be viewed with concern from Saudi Arabia to Venezuela.

The clamor to hedge -- locking in future cash flows and sales prices -- could translate into higher U.S. oil production next year, offsetting an output cut that the Organization of Petroleum Exporting Countries outlined in Algiers last week. Shale firms in particular would enjoy extra income to pay for additional drilling.

“We are seeing significant producer flows which early estimates suggest could be the highest we have seen all year,” Adam Longson, commodity strategist at Morgan Stanley in New York said in a note to clients.

Crude futures in New York surged more than $4 a barrel since OPEC surprised traders by agreeing to trim output at a gathering in Algiers on Sept. 28. West Texas Intermediate traded at $48.77 a barrel, down 4 cents, at 6:58 a.m. Singapore time on Tuesday after closing at the highest in three months.

Harry Tchilinguirian, head of commodity research at BNP Paribas SA in London, said on Friday that OPEC had thrown a “lifeline” to U.S. shale firms, prompting them to hedge “in droves.” The bank has “seen many queries coming through” from producers, he said.

The WTI 2017 calendar strip -- an average of future prices next year that’s often used as a reference for hedging activity -- rose above $50 a barrel to its highest since August on Monday. “When calendar 2017 pricing rises into the low-to-mid $50s, as it is doing now, producer hedging rises materially,” Longson said.

U.S. shale producers used a similar rally to hedge their prices in May, when the WTI 2017 calendar strip also rose above $50 a barrel. The current activity comes after industry executives told investors in July and August they planned to use any window of higher prices to lock-in cash flows for next year.

"We would like to be a little bit further hedged than we are today," Pioneer Natural Resources Co. Chief Executive Officer Tim Dove said back in July, noting his company has locked in prices for up to 55 percent of its 2017 exposure. “I’d like to see us get that number up as we go towards at the end of this year.”

U.S. independent oil companies have only hedged 16 percent of their price exposure for 2017, compared with 39 percent for the rest of this year, according to Houston-based boutique investment bank Tudor, Pickering, Holt & Co. "We expect hedge book conversations to tick up during the next round of quarterly calls," it said in a note to clients on Friday.

U.S. shale companies and other independent exploration and production companies usually reveal their level of hedging with a quarter delay. Nonetheless, anecdotal pricing activity already suggests their presence in the market.

The WTI price curve, for example, has flattened over the last week, with spot prices rising more than prices for delivery next year, suggesting producer selling in 2017 and beyond. The spread between the WTI contract for immediate delivery and a year forward narrowed on Friday to minus $4.12 a barrel, from minus $4.77 a barrel before the OPEC meeting. The trend continues further down the curve too, with the spread between oil for delivery in Dec. 2017 and Dec. 2018 also contracting sharply after the decision in Algiers.

At the same time, the open interest in the WTI June 2017 contract has jumped nearly 10 percent over the last week, while the December 2018 contract rose 6.5 percent, another indication of hedging activity. Open interest across all WTI contracts rose by 66,000 lots -- the equivalent of 66 million barrels of oil -- from Tuesday to Friday last week, according to preliminary CME data. The total volume of crude futures on ICE and Nymex combined hit a record on Wednesday, the day of the Algiers meeting at which OPEC members agreed on a plan to limit output.

“Every time prices get above the $50 range we see a lot of activity coming in from producers selling into the rally,” said Hamza Khan, an analyst at ING Bank NV in Amsterdam.

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