As oil prices began recovering from 13-year lows early this year, US shale producers ramped up their hedges against another slump on a scale unseen for at least a year, a Reuters analysis of company disclosures shows.
A review of disclosures by the largest 30 US shale firms showed 17 of them increased their hedge books in the first quarter, the most at least since early 2015.
Several, including EOG Resources Inc. and Devon Energy Corp, two of the biggest shale companies, secured significant protection of future earnings for the first time in at least six months.
A greater volume of hedged production typically indicates more drilling activity ahead as producers that locked in prices for a sizeable part of their output ensure enough cash flow to sustain or increase production.
What makes the outlook more complicated this time is the fact that oil companies, fearing the rally could fizzle, locked in sales at levels around $10 a barrel below both current prices and break even levels for some producers.
For those producers the concern is that their margins will suffer if service costs rise as activity picks up.
It is less clear how it will affect production, though most analysts expect more supply.
Michael Cohen, head of energy commodities research at Barclays in New York, believes hedges allow producers to plan better even if they secured prices below present levels just below $50 a barrel.
“I think (the hedging) gives producers more security to lock in a capex plan,” Cohen said, predicting shale production will edge up in the second half of the year.
The 17 companies locked in prices for nearly 55 million barrels of future production, the highest volume in at least a year and some 45 percent more than hedges added by eight companies in the fourth quarter.
The spike in hedging came as crude recovered from February’s 13-year lows around $26 a barrel later in the first quarter, a rally that continued into the second quarter.
That recovery stalled, however, in the final weeks of last month amid heightened uncertainty about the impact of Britain’s vote to leave the European Union and crude prices slipped back below $50 a barrel.

FIRST QUARTER BORROWING

Sometime in the first quarter, Marathon Oil Corp, for example, hedged at an average price of $39.25 for the second quarter, when prices averaged just below $46 a barrel. Denbury Resources Inc. locked in first-quarter 2017 US crude production at just over $42 a barrel; those futures this week were trading at about $52 a barrel.
While those deals may look problematic now, analysts point out that they did make more sense three or four months ago.
Michael Tran, director of commodity strategy at RBC Capital Markets in New York, said that at the time market players had expected oil prices to average at or below $40 this year.
“You have to remember that sentiment in this market is still so fragile,” he said. 
“Producers ended up locking in something in case we did a double dip.”
For those that have enough money, the hedges may now act as an incentive to crank up production for the spot market to average up how much they fetch per barrel, said John Saucer, vice president of research and analysis at Mobius Risk Group in Houston.
For a number of oil producers hedges were more of a necessity than a strategic choice as they needed them to get bank loans, said Thomas McNulty, a director at consultancy Navigant, who advises producers on valuation, transactions and risk management such a hedging.
“Banks have been working very hard with their clients to continue or extend financing, and that requires producers to hedge more,” McNulty said, adding that he saw limited appetite for hedging that went beyond what banks required.

Source: Arab News