Industry Trend Analysis - Hedging Offers Little Upside To Output - FEB 2018

BMI View : Hedging activity in the US shale patch will support more stable cash flows and protect producers against a relapse in prices. It offers limited upside to production, in light of the industry 's sharpening focus on margins over growth.

The surge in oil prices in Q417 has supported increased hedging amongst US shale exploration and production companies (E&Ps). On a month-on-month basis, the number of short WTI futures and options contracts held by swap dealers (a proxy for hedging activity) rose by 11.7% in October and 17.3% in November. The number continued to rise in the first week of December, albeit marginally so (0.6%).

US E&Ps had already been building their hedged positions in the first three quarters of the year. According to data from Bloomberg, based on a basket of 53 companies in North America, as of end-Q3, the weighted average volume of production hedged for 2018 stood at 28.8%; the median volume was 40.4%. Depending on which hedges are used, they often entail an initial net capital outflow and can sacrifice upside to prices. However, they effectively eliminate downside price exposure and help to secure more stable and more forwardly-transparent cash flows. Given the short-cycle nature of the industry and its heavy reliance on access to capital markets, this is of significant value to shale E&Ps.

Hedging Activity Spiking
Swap Dealers Combined Short Futures & Options Positions In NYMEX WTI
Source: Bloomberg, CFTC

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