As U.S. Shale Hedges Post-OPEC, Oil Market Turns Upside Down

Pushing the forward oil curve upside down, bankers, merchants and brokers said that U.S. shale oil companies are using the post-OPEC rally to hedge their oil price risk for next year and 2018 above $50 a barrel.

Offsetting the first output cut by the Organization of Petroleum Exporting Countries in eight years, higher U.S. oil production next year would be the result of the rush to hedge — locking in future cash flows and sales prices. As such, the producer group could end throwing a life-line to a sector it once tried to crush.

“Right after OPEC, U.S. producers were very active hedging,” said Ben Freeman, founder of HudsonField LLC, a boutique oil merchant with offices in New York and Houston. “We are going to see a significant amount of producer hedging at this levels.”

Violent movements across the price curve were triggered by the hedging pressure.

The shape of the curve flattened as shale firms sold oil for delivery next year and early 2018. “The curve is screaming producer hedging,” Adam Ritchie, founder of consultant AR Oil Consulting and a former trading executive at Caltex Australia Ltd. and Royal Dutch Shell Plc. said.

In a condition known as backwardation, West Texas Intermediate crude for delivery in December 2017 is now more expensive than in June 2018. Known as contango, the forward curve was in the opposite shape a week ago.

“The longer dated flattening in the futures curve does indeed reflect to a large extent increased producers activity, hedging on the back of the pop up in spot prices that followed the announcement of an output cut by OPEC,” said Harry Tchilinguirian, head of commodity strategy at BNP Paribas SA.

When crude rises into the mid-$50s, the latest surge in prices extends U.S. shale drillers’ pattern of adding hedges. It increased its hedges for next year to 75 percent of production from 50 percent. Said Pioneer Natural Resources Inc., for example, said in early November. From the prior three months, Devon Energy Corp. more than quadrupled its 2017 in the third quarter.

Their level of hedging with a quarter delay is usually revealed by the U.S. shale companies and other independent exploration and production companies. Nonetheless, their presence in the market is already suggested by anecdotal pricing activity. They handled significant volumes after OPEC agreed to cut production, U.S.-based oil bankers and brokers also said.

While the number of puts — used by producers to guarantee a minimum price — hit the highest since 2012, a record 580,000 crude options contracts traded on the New York Mercantile Exchange that day.

Doubt about whether OPEC and Russia will continue to curb supply when the deal ends in six months is another factor keeping pressure on forwards prices.

“Two things might be priced in this change — the first one is that shale producers are hedging and the second one is that the deal is for six months and then no one knows what’s going to happen,” said Tamas Varga, analyst at brokerage PVM Oil Associates Ltd.

(Adapted from Bloomberg)

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