(OXY), Hess Corp. (HES) and Continental Resources (CLR)
—have none or very little of their 2017 production hedged.
However, seven of the 10 were unhedged at the end of the
third quarter of 2016, and two others had less than 20% of
their output protected. In the fourth quarter of 2016, Apache
Corp. (APA) and Anadarko Petroleum (APC) moved from no
hedges to 33% and 24% production protected, respectively,
while Noble Energy’s (NBL) hedging percentage jumped
from 4% to 36%.
The obvious outlier among the largest E&Ps is Pioneer
Natural Resources (PXD), which has the largest acreage position of any E&P in the Permian’s Midland Basin. While our
universe of E&Ps was cutting capital expenditures by an average 51% from 2015 to 2016, Pioneer maintained relatively
level investment, which drove a 14% production increase. To
support that investment, the company had nearly 60% of
output hedged going into the fourth quarter of 2016, then
boosted that to 84% by the end of last year—the highest in
our group—to support a 27% increase in 2017 investment to
generate a 17% output increase.
In line with the historical trend, 16 of the 19 smallest companies had 40% or more of their 2017 production hedged by
the end of 2016. Some smaller E&Ps had substantial hedges
in place prior to the price rise in the fourth quarter of 2016;
for example, the percentage of production protected at the
end of the third quarter was 75.3% for EP Energy (EPE) and
72.3% for WPX Energy (WPX). The most dramatic increases
were RSP Permian (RSPP; 9% to 54%), Northern Oil & Gas
(NOG, 27% to 66%) and Oasis Petroleum (OAS, 40% to 61%).
The outlier in this group is the small Permian producer Approach Resources (AREX, to the far right), which took a very
different strategy after renegotiating part of its substantial
debt. This producer hedged 85% and 50% of its 2017 natural
gas and NGL production, respectively, while aiming for higher returns from totally unhedged oil output. It remains to be
seen how this strategy works out.
Approach Resources’ strategy is not only different for a
company of its small size, but also for a company with high
leverage. Bloomberg compared the percentage of oil produc-
tion hedged with the net debt-to-equity ratios for the 37
companies in our group, as shown in Figure 2.
It’s no surprise that one-third of the companies in the bot-
tom-left quadrant, which have net debt-to-equity ratios of
below 2X, have relatively lower levels of hedge protection.
Their strong balance sheets provide a cushion against price
All of the companies in the upper left quadrant, which
have more than 50% of output protected despite solid bal-
ance sheets, produce from the Permian Basin, which is re-
ceiving the highest level of capital investment in 2017. They
want to protect against lower oil realizations, which would
erode or erase the profit margin from the production growth
they are expecting to generate. As you might expect, the vast
majority of the companies with higher debt-to-equity ratios
(to the right of the vertical gold line) are relatively well-
hedged. These producers can least afford taking on addition-
al debt to fund a significant gap between spending and cash
flow should prices drop. Again, the exception is Approach
Resources, the strategy of which we discussed previously.
A second major issue to discuss in analyzing oil hedging,
beyond the percentage of production protected, is the average strike price of the transactions. In this regard, this new
period of renewed hedging activity is very different from
those bygone days of $100/bbl crude oil prices. Now, the futures curves are largely flat, so the average futures price from
now to December 2022 is $49.60/bbl (May 5’s close). The
good news, as we explain in our Piranha! study, is that many
E&P companies operating in the right geographies can generate healthy returns at that price level after narrowing their
focus to core areas of the most productive resource plays
and taking advantage of lower service costs and rising drilling efficiencies. Two-thirds of 2017 E&P capital investment
is allocated to just five plays: the Permian, Eagle Ford,
SCOOP/STACK, Marcellus, and Bakken. Drilling and completion and lease operating expenses (LOEs—see RBN Energy’s LOE-down series) have fallen more than 50% since year-end 2014 in these plays. As a result, most E&Ps have been
able to balance spending and cash flow; in 2016, the median
company investment exceeded cash flow by just 5%. The increase in 2017 hedging protection will help protect producers and allow them to fund their higher capital investment to
drive production growth.
It is unclear, however, if this protection will be available in
2018 and beyond. Only 21 of the 37 companies our friends at
Bloomberg examined currently have any 2018 oil hedges in
place, and those average less than 10% of expected output.
Negligible production is protected in 2019 and 2020. The
ability to strike acceptable hedge deals in future years will
depend on the future global supply demand balance. We’ll
continue to keep an eye on E&P investment trends and
If you have a Bloomberg terminal, check out Bloomberg
BI’s new report that provides the source data for this blog. It
is a customized, granular look into the hedging strategies of
the 37 largest US E&P companies.
ABOUT THE AUTHOR
Tom Biracree is currently a director at Oil and Gas
Financial Analytics LLC. He was Senior Principle
Editor at John S. Herold Inc., then IHS Inc., for 15
years. He led the senior editorial team for IHS Energy Insight research and was responsible for structuring and content editing valuation and transaction research. Biracree wrote the Herold Oil Headliner, a daily
newsletter aimed at senior industry and financial executives.
He was co-author of the Global Upstream M&A Review and
contributed to the Global Upstream Performance Review. He
can be reached at email@example.com.