After reducing capital expenditures by 70% in 2014-16, U.S. exploration and production companies (E&Ps) have collectively taken their foot off the brake and stomped on the gas, boosting 2017 capital outlays by an impressive 42% to kick-start production growth. At first glance, the move may seem somewhat reckless. After all, E&Ps just weathered a crisis caused by plunging oil prices partially through impressive capital discipline, and the price for benchmark West Texas Intermediate (WTI) crude oil has once again drifted below $50/bbl over concern that U.S. output may be rising too fast. But as we’ve learned from a new report by our friends at Bloomberg Intelligence, most major U.S. oil producers paired their increased investment with significant oil-price protection, aggressively snapping up hedges in late 2016 as oil prices were buoyed by the announcement of planned OPEC output cuts. Today we review BI’s examination of the efforts by many E&Ps to lock in $50/bbl-plus prices for much of their 2017 production.
The surge in hedging activity by U.S. E&Ps is another indicator of an ongoing transformation of the E&P sector that we analyzed in depth in Piranha!, a new market study of 43 representative U.S. E&Ps. Of that universe of companies, 21 focus on oil (60%+ liquids reserves), nine are gas-weighted producers (60%+ natural gas reserves) and 13 are diversified producers. All major U.S. shale/unconventional plays are represented in the combined portfolios of these firms. In Very Particular Places to Go, we discussed the purpose and organization of our analysis, which included an examination of the strategies that E&Ps are adopting to thrive in a $50/bbl world; a look at merger and acquisition (M&A) activity by basin; and a review of each company’s financial condition, capex plans, geographic focus, M&A strategies and a general assessment of the company’s position in today’s U.S. E&P industry.
Then, in Jump!, we took an initial look at the 2017 capital spending plans of the three peer groups of E&Ps—Oil-Weighted, Gas-Weighted and Diversified. We took a deep dive into the Oil-Weighted peer group in Higher Ground, considered the Gas-Weighted group in Let It Grow and zeroed in on the Diversified E&Ps in in Reinvent the Wheel.
Now, thanks to a great new offering from Bloomberg Intelligence (based on research by BI’s Matt Hagerty and Peter Pulikkan), we can add another perspective on the financial effect of the E&P’s 2017 investment plans by looking at the resurgence in oil hedging. First, a little background on hedging for those not steeped in this tool many oil producers use for “price insurance”. Producers constantly weigh the certainty of locking in a price for future production, which protects against price drops, with the risk of giving away substantial revenue or paying out “floor” options premiums if prices rise. The percentage of volumes hedged tends to decline when the outlook for rising oil prices is strong, such as the “peak oil” period in 2006-08 (see Cover of the Rolling Stone), and when declining future curves make locking in attractively high prices difficult, such as the period from late 2014 to early 2016. Price protection becomes much more attractive when oil prices are threatened on the downside and investment is increasing—like now.