Energy markets remain volatile and cash is king for today’s oil and gas producers. One tool used by industry to aid in cash flow is an effective hedging program.
Based on information disclosed in December 2018 regulatory filings, a mid-year analysis by Opportune LLP of 30 of the largest public oil and gas producers showed that, consistent with prior years, the majority of public oil and gas producers maintain hedges for crude, natural gas, or natural gas liquids as a way to fund the capital intensive work of searching for, developing, and extracting hydrocarbons. In fact, 93% of 2018 surveyed companies hedged some level of price risk. Not only do companies need cash to ensure that oil and gas continue to flow, “but also to make debt payments, comply with debt covenants and support the general and administrative costs,” said analysis authors Shane Randolph, managing director, Opportune; and Josh Schulte, a manager in the firm’s commodity risk management advisory group.
“An upstream company without hedges will benefit from higher market prices, but they have a very short amount of time to react when market prices decline. This is a predicament many upstream companies experienced during the 2014 price downturn,” they said.
For investors looking at energy companies’ hedging programs, careful attention should be paid to instrument types.
“For a producer,” they noted, “swaps provide the highest amount of downside protection. However, swaps limit upside price participation. This leads producers to utilize purchased puts, which can be costly, or costless collars, which allow the producer to participate within a range of price movements. Other instruments noted in the survey were swaptions and three-way options. Swaptions continue to represent a minority of the instrument types utilized by the public companies.
“Use of three-way options were common in higher price environments when oil prices were over $80/bbl,” the firm said, but beware the ‘trap door,’” the authors said. For example, “a producer with a $40/bbl sold put, $50/bbl purchased put and $60/bbl sold call would participate in price movements between $50/bbl and $60/bbl. However, once the price goes below $40/bbl, the company would have no downside protection as the price falls below $40/bbl. This was particularly painful for many producers in 2014 that had sold puts in the $65-$75/bbl range under the belief that prices could never go below those levels,” the authors said.
Based on the public oil and gas companies reviewed by Opportune in the sample, swaps were the preferred instrument for both natural gas and crude and a strategy with both swaps and collars implemented was common for both crude and natural gas. When compared to the prior year, instrument types for gas remained generally consistent, the research noted, but that wasn’t the case for crude, where the use of swaps decreased and the use of purchased puts increased.
An interesting note from the survey results, the authors said, was that while a higher percentage of companies hedged crude than natural gas in 2020, more companies have hedged natural gas in 2021 to 2023 than crude.
The authors also noted price as available. “For the 27 companies that disclosed hedged price levels, the average swap price for crude was $57.85/bbl for 2019 and $61.30/bbl for 2020 and natural gas was $3.05/MMbtu for 2019 and $2.82/MMbtu for 2020. The average put price (non-three way) for crude was $57.96/bbl for 2019 and $58.21/bbl for 2020 and natural gas was $2.93/MMbtu for 2019 and $2.74/MMbtu for 2020.”
When it came to information regarding hedges for forecasted production, few companies disclosed. “Only seven companies disclosed a percentage of forecasted production hedged. For the companies that did disclose this information, the average hedge level for crude was 47% of forecasted 2019 production and, for natural gas, was 62% of forecasted 2019 production,” the authors said, noting hedge levels include coverage provided by three-way options.
Mikaila Adams | Managing Editor - News
Mikaila Adams has 20 years of experience as an editor, most of which has been centered on the oil and gas industry. She enjoyed 12 years focused on the business/finance side of the industry as an editor for Oil & Gas Journal's sister publication, Oil & Gas Financial Journal (OGFJ). After OGFJ ceased publication in 2017, she joined Oil & Gas Journal and was named Managing Editor - News in 2019. She holds a degree from Texas Tech University.