Many top US shale oil producers are missing out on the rally in oil prices to more than $70 a barrel – because they sold their oil through futures contracts at about $55 last year when that looked like a good deal. Now, it looks cheap.
Those hedged bets will hold down revenues and further frustrate Wall Street investors, who have been disappointed by slow returns from the booming Permian Basin in west Texas.
The top 25 shale producers will forego about $1.7 billion in combined revenues in the second quarter with oil prices at about $70, according to Denver-based consultancy PetroNerds. Many of those producers used hedges that guaranteed them between $55 and $58 a barrel.
Some west Texas producers face a second profit-limiting dynamic: They are forced to cut prices because the region’s production is overwhelming its pipeline network, raising transportation costs.
West Texas oil currently trades at a discount of $9 to US benchmark futures, a spread that hit $12 earlier in the month.
Some firms earlier protected themselves from the widening gap with hedges against the discount.
But those that didn’t – and also hedged against future prices at, for instance, at $55 – have been forced to sell barrels at prices in the low-to-mid $40s.
Occidental Petroleum Corp, the biggest oil producer in the Permian, hedged using west Texas crude futures priced at about $59 a barrel, according to first-quarter regulatory filings. The company did not hedge against the Midland differential.
Occidential, which produces about 226,000 barrels per day (bpd) from the Permian, declined to comment on its hedging strategy. It could offset softer drilling revenues with better results from its pipeline unit, which benefits from the rising transportation costs.
Lost Upside
Many firms sold their future output at prices in the $50s last year, hoping to take advantage of short-term rallies to lock in guaranteed income to cover drilling and production costs. Those costs can be $30 a barrel or less in west Texas, allowing the firms a healthy profit even as they protected themselves against future price slumps.
But the cost of that protection is to forego the potential upside of higher prices.
The second problem, with pipeline capacity, stems from surprisingly quick production growth that has pushed pipeline capacity to the limit several months before producers expected, said Michael Tran, global energy strategist at RBC Capital Markets.
Producers in west Texas, the nation’s largest oilfield, are now pumping more than 3.3 million bpd, compared with 2.4 million bpd a year ago. With storage brimming and pipelines full, producers have had to offer steep discounts to compensate for rising transport costs.
The large gap between the US futures price and Permian Basin oil is called the Midland differential – named for the town at the center of the west Texas oilfield boom.
Until recently, firms had not hedged the discount because the price of Midland oil and US futures have historically tracked closely together. The market for such hedging is also less active, compared with futures hedging.
But at the end of the first quarter, 14 shale companies had hedged against 100 million barrels of 2019’s production in West Texas, compared with just 40 million barrels at the end of the fourth quarter, according to a Reuters analysis of US regulatory filings.
Published in Daily Times, June 14th 2018.
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