US shale oil producers are expected to suffer more than $10 billion in derivative hedging losses this year if oil prices remain around $100 a barrel, Rystad Energy has said.
Many shale operators offset their risk exposure through derivative hedging, helping them to raise capital for operations more efficiently, the Oslo-based energy research company said on Tuesday.
Producers who hedged at lower prices last year are in line to suffer significant losses as their contracts mean they cannot capitalise on the high prices, it said.
The sheer scale of the losses has resulted in companies spending hundreds of millions of dollars to exit their positions.
“With huge losses on the table, operators have been frantically adapting their hedging strategies to minimise losses this year and next,” said Rystad Energy vice president Alisa Lukash.
“As a result, we may not have seen peak cash flow in the industry yet — which is hard to believe, given the soaring financials reported in recent weeks.”
Shale producers can lose money on hedges in a couple of ways. Companies using “collars” to insure against a downturn will buy put options that allow them to sell their oil at a predetermined price.
But to fund those puts, they simultaneously sell bullish call options that pay a premium while capping their exposure to higher prices.
Those hedging with swaps can incur losses when prices rise above the fixed levels at which they are sold.
Oil prices have remained volatile this year. Brent touched about $140 barrel in March. However, it gave up most of its gains in the last few months as concerns grew over the possibility of a recession hitting fuel demand globally.
In July, the International Monetary Fund lowered its growth forecast for the global economy to 3.2 per cent this year, from its previous forecast of 3.6 per cent in April, owing to Russia’s war in Ukraine, high inflation and the Covid-19 pandemic.
Brent, the global benchmark for two thirds of the world's oil, was trading 0.48 per cent lower at $94.64 a barrel at 6.42pm UAE time on Tuesday.
West Texas Intermediate, the gauge that tracks US crude, was down 0.39 per cent at $89.06 a barrel.
Hedging paid off during the coronavirus-induced crash of 2020 but turned painful as recovering economies and Russia’s war in Ukraine lifted energy prices to historic highs.
“Anticipating the significant negative impact of these hedges, shale operators made a concerted effort in the first half of this year to lower their exposure and limit the impact on their balance sheets,” Rystad said.
Many operators have successfully negotiated higher ceilings for 2023 contracts and, based on current reported hedging activity for next year, even at a crude price of $100 per barrel, losses would total $3bn, a significant drop from this year, according to the research company.
“At $85 per barrel, hedged losses would total $1.5bn; if it fell further to $65, hedging activity would be a net earner for operators,” Rystad said.
Despite hedging losses, record-high cash flow and net income have been widely reported by US onshore exploration and production (E&P) companies this earnings season.
“These operators are now adapting their strategies and negotiating contracts for the second half of 2022 and 2023 based on current high prices, so if oil prices fall next year, these agile E&Ps will be able to capitalise and will likely boast even stronger financials,” Rystad said.
E&P companies typically employ derivative hedging to limit cash flow risks and secure funding for operations.
US shale operators currently have 42 per cent of their total guided and estimated oil output for 2022 hedged at a WTI average floor of $55 a barrel.
Overall, producers have hedged 46 per cent of their expected crude oil output for the year.
In the second quarter, companies reported an average negative hedging impact of $21 a barrel on their realised crude prices — the value they receive for production minus any negative hedging impact.
Fewer companies reported any significant effect on their derivatives contracts in the latest quarter, compared with the previous three months.
“An analysis of the difference in the hedging impact on realised prices per operator between the first and the second quarter shows that in most cases, second-quarter losses were stronger by $4 per barrel on average,” Rystad said.