U.S. oil and gas companies currently have hedge protection in place for less than one-fifth of their expected 2016 production, and the strike price of the remaining derivatives is significantly lower than in previous years. With a bleak gas price outlook for 2016, the result could be even more severe capital spending reductions, potential production curtailments, and increased financial stress for mid-size and smaller firms. In today’s blog, we examine what has happened to producer hedging protection and the implications for capital spending and production trends.
The Rolling Stones lyrics from 1969 must be echoing in the minds of gas producers today: “Oh, a storm is threat’ning, my very life today; if I don’t get some shelter, oh yeah, I’m gonna fade away.” In recent weeks there have been a spate of reports from banks and consultants that warn of more pricing problems facing U.S. gas producers. During 2015, about half of gas production was hedged out. But that will drop like a rock in 2016, down below 20% according to most reports. Worse yet, the price of those hedges is also headed south. Given the potential impact on producer drilling activity and ultimately on production, we thought it would be a good idea to look at the numbers.
But before we start – a quick disclaimer. We are not an investment advisor. The purpose of this blog is not investment advice or endorsement. RBN looks at company level numbers to see what they mean for the market as a whole, not implications for any particular company’s stock.
Current natural gas market conditions make this a particularly bleak time to be exposed to market prices. Henry Hub spot prices averaged $2.07/MMbtu in November; the lowest level seen since 1998, and according to NGI the spot price plunged below $2.00/MMbtu in the first week of November for the first time since the summer of 2012. As we pointed out in “Breakdown: U.S. Natural Gas Storage Hits 4 Tcf for the First Time”, working natural gas inventories recently reached an all-time high. We also detailed the threat to winter gas prices in “A Hazy Shade of Winter – Shadow of Storage Surplus Threatens Winter Natural Gas prices” and “Hazy Shade of Winter Part 2”. In its November 2015 Short Term Energy Outlook, the U.S. Energy Information Administration said it expects warmer than average temperatures caused by the strong El Nino in the Pacific Ocean will reduce winter heating demand and provide little price relief to gas producers. And with the CME/NYMEX forward curve below $3.00/MMbtu until December 2017, the access to additional shelter for next year’s volumes doesn’t look good.
The lack of price protection and weak prices will mean significantly lower cash flows, which is likely to trigger additional capital spending reductions and the possibility of production curtailments for the universe of producers, regardless of size. The most significant impact will be further reductions in cash flow for mid-size and smaller producers, which have been struggling with high debt.
Large E&Ps virtually unhedged but supported by balance sheet strength
According to most of the reports we’ve seen, large E&Ps have less than 10% of their 2015 natural gas production hedged. These large companies make up more than 75% of production, so their capital spending reductions and production curtailments are major factors in 2016 gas supply.