Oil and gas producers are continuing to hedge production, according to a recent survey authored by Opportune Managing Director Shane Randolph and Senior Consultant Josh Schulte.
After studying hedging activities of the 30 largest public oil and gas producers as disclosed in their Dec. 31, 2017, 10-K filings, Randolph said that 97% of oil and gas producers continue to hedge production.
Hedging is like a risk management program that equips companies to deal with the unpredictable market, especially as oil and gas prices remain unstable. According to the survey, "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 have experienced during the most recent price downturn. This is likely why almost all of the companies in the survey have hedges in place."
The survey also concluded that few companies are hedging beyond 2019.
Randolph explained during an interview with Hart Energy that hedging is challenging in that it requires companies giving up their upside in a crisis environment but its crucial to protect the downside if the market prices collapse again.
The survey also studied the instruments of hedging such as three-way collars, purchased puts and swaptions for natural gas and crude oil hedgers.
"Another important finding of the survey was that while swaps remain the preferred instrument for hedging, natural gas hedgers are moving toward using three-way options over costless collars," Randolph said.
He believes that the reason behind this choice of instrument is the depressed state of the natural gas market. According to the survey, "swaptions represented a minority of the instrument type utilized by the public companies. The use of three-way options (purchased put, sold call and sold put) were common in higher price environments when oil prices were over $80 per barrel (bbl)."
Furthermore, when oil prices continue to decline, hedging programs are not a permanent fix. The survey concluded that "during the most recent downturn, many of the upstream companies with attractive hedging portfolios were hedged 12 months to 24 months ahead of their future production, which shielded them during 2015 and a portion of 2016.
"Furthermore, while companies that hedged natural gas were larger than those that hedged crude in 2018, five companies also hedged 2019 or beyond.”
Randolph added that majority of the companies are hedging 24 months ahead and private companies are hedging around 36 months ahead, which is more than the public companies.
The survey not only studied the instruments and duration of hedging, but also the price levels at which companies executed hedging. The survey reports that in the past few years, after companies restructured balance sheets and successfully negotiated lower operating costs, their break even production price consequently decreased.
Out of 26 companies that disclosed hedged price, "the average swap price for crude was $50.64 for 2017 and $53.50 for 2018, and natural gas was $3.15 for 2017 and $3.06 for 2018. The average put price (non-three-way) for crude was $47.42 for 2017 and $48.54 for 2018, and natural gas was $2.95 for 2017 and $2.94 for 2018."
Implementing an effective hedging program can help companies ensure certainty of cash flow and could prevent them from having to file for bankruptcy. Randolph further clarified the concept of hedging and said, "“Companies hedge to protect their operating cash flow so they can meet their debt payments and CapEx budgets. It's crucial for oil and gas companies to treat a hedging program as a means to protect cash flows from production and not view it as a separate profit center."