Risk Management

At the start of the fourth quarter, representative peer groups of U.S. oil and gas producing companies active in shale plays had reduced their 2021 hedged oil volumes by 25% and hedged gas volumes by 4% compared to 2020, according to analysis from Rystad Energy. However, the report notes that operators are continuing to adjust their hedging strategies moving toward the end of the calendar year, and the amount of anticipated 2021 production under some type of hedge contract was expected to increase.

The analysis included 20 producers that collectively account for 32% of 2020 oil output in shale plays, and 10 operators whose net production represents more than 20% of the total 2020 shale gas output. Rystad reports that the shale oil group had hedged 41% of their total forecasted 2021 oil output as of early October at an average price floor of $42 a barrel, which is $14/bbl lower than the 2020 floor of $56/bbl. The shale gas operators had hedged 45% of their expected natural gas production at a floor price of $2.58 per million Btu, which is marginally lower than this year’s $2.70/MMBtu floor.

For operators active in tight oil basins, Senior Shale Analyst Alisa Lukash noted in a report that hedging strategies have “taken center stage as a tool that is helping companies cushion their cash flows amid weak oil prices.” The analysis includes all contracts with full or partial floor protection: swaps, collars and three-way collars referencing different price strips (i.e., WTI Midland, WTI Houston and Brent). For its analysis, she explains that Rystad Energy converted all price benchmarks to a WTI New York Mercantile Exchange equivalent, assuming a spread of $0.30/bbl for WTI Midland, $0.70/bbl for WTI Houston, and $2.50/bbl for Brent.

The share of three-way collars has dropped significantly, accounting for only 17% of the 2021 settlements compared with 41% in 2020, the report points out. “This change comes after the collapse in the crude market (in response to COVID-19) in early 2020 meant that prices broke the subfloor of most of these contracts, generating only around $10 uplift to the pre-hedged realized price,” Lukash writes.

Oil Hedging Strategies

Rystad’s analysis looks at the hedging strategies of leading Permian Basin producers such as Occidental Petroleum, Laredo Petroleum, Pioneer Natural Resources and Diamondback Energy. “Interestingly, Occidental has sold a large volume of call options for 2021 settlement, even though these contracts alone are not considered hedging contracts because they have no floor protection,” the report reads. “They provide a price ceiling at around $74/bbl (Brent) and can potentially be combined with the puts to create a collar or a three-way collar in the future, similar to the operator’s 2020 derivative strategy. That means the share of its 2021 three-way collars might still grow significantly in coming quarters.”

In its third-quarter conference call in early November, Oxy detailed its oil hedging program, noting that the three-way costless collar enhances monthly cash flow by $106 million when Brent averages less than $45/bbl during a calendar month. Rob Peterson, senior vice president and chief financial officer, also outlined Oxy’s two-way costless collar for a large portion of its 2021 gas production, with a short call of $3.64 and a long put of $2.50.

“We implemented a natural gas hedging program for 2021 to further derisk our cash flow profile with a costless collar with a floor of $2.50,” Peterson stated. “We have hedged 530 million cubic feet a day, representing almost 40% of our domestic gas production. We continue to approach hedging on an opportunistic basis and may consider additional oil and gas hedges for future years.”

Laredo Petroleum, Pioneer Natural Resources and Diamondback Energy had hedged significant amounts of their expected oil production against Brent benchmark prices. The calculated floor, in some cases, is also an actual price per barrel in a swaps contract. The distribution of the hedged volumes varied widely. Pioneer secured large volumes through three-way collars, only adding an extra ceiling to capture premiums for its 2021 settlements (short calls), according to the report. As of early November, Diamondback had hedges in place to provide downside protection on more than 50% of its expected 2021 oil production volumes at a weighted average price of $38.18.

Only three operators–Marathon Oil, Murphy Oil and Ovinitiv–had less than 20% of their expected 2021 oil production hedged at the start of Q4. At the other end of the spectrum, only three companies–SM Energy, Laredo, and Parsley (acquired by Pioneer in mid-October)–had more than 60% of their forecast 2021 output protected.

“Most others come in between 20% and 60%,” Lukash states. “Some of the names on the chart, mainly highly leveraged companies, added hedges in early 2020 to cover a large volume of their expected output, taking advantage of a higher strip price.”

In its third quarter conference call on Nov. 6, Laredo announced that it had received $58.2 million from its commodity derivatives programs during Q3. For 2021, the company has hedged more than 8 million barrels of oil production at an average weighted Brent floor price of $50.80, 42.5 million MMBtu at an average Henry Hub price of $2.59, and 2.2 MMbbl of natural gas liquids at various prices specific to NGL stream component products.

“We are 80% hedged on the oil side for 2021,” said Laredo President and CEO Jason Pigott. “Gas presently is not hedged quite as heavily at roughly 62%, but we will continue to consider locking in hedges as we go forward if we see higher prices.”

Laredo’s robust hedge position at prices above the current strip for 2021 supports future development activities and helps solidify its position in the property acquisitions market, Pigott suggested. “There should be plenty of opportunity in our backyard. Again, we are heavily hedged. There are a lot of other companies that are not hedged to the degree we are that will be more financially stressed next year,” he commented. “We have the liquidity to go pick up acreage at all-time lows or discounts.”

Gas Producers

Generally, the 10-company shale gas peer group is well hedged, although there was still room for additional hedge positions to be layered on in 2021 given that the companies had hedged nearly 70% of their 2020 volumes and bullish market views on natural gas prices through next year, Lukash notes. Notable outliers included Antero, which had hedged most of its production by the start of Q3, as it had in 2020, and at a higher floor price, she observes.

Cabot Oil & Gas, which Lukash says has historically maintained a low hedging profile, announced a hedging program in early October consisting of 138.5 million MMBtu of NYMEX natural gas collars with a weighted average floor price of $2.63/MMBtu and a weighted average ceiling price of $3.01/MMBtu. Cabot also has 18.3 million MMBtu of natural gas swaps with a weighted average NYMEX price of $2.74/MMBtu.

“Given the improvement in the 2021 NYMEX futures during the third quarter, we have implemented a price risk management strategy for 2021 to mitigate downside risk while still offering upside potential,” Chairman, President and Chief Executive Officer Dan Dinges remarked. “Our hedging strategy continues to be focused on opportunistically locking in downside protection while maintaining some level of market price exposure if natural gas prices continue to move higher as a result of improving natural gas balances.”

EQT Corp., the largest natural gas producer in the United States, aggressively expanded its hedge position in the third quarter as prices rallied, according to Chief Financial Officer David Khani. “As prices were rising, we were opportunistically adding 2021 hedges to lock in value and protect downside risk with two key goals in mind: paying off our remaining $900 million of 2021 and 2022 debt with free cash flow, and secondly, locking in investment-grade metrics,” he stated during EQT’s quarterly conference call in late October. “With this hedge position and a strong 2021 and rising 2022 strip, we believe we have achieved these key milestone goals.”

As a result, 72% of EQT’s 2021 expected production was hedged at the start of the fourth quarter, up from the 40% at the end of the second quarter. Through collars and swaps, the company’s average per-dekatherm weighted prices for 2021 range between $2.66 and $2.96. Khani added that the company’s hedge program is designed to provide downside protection while preserving upside value capture opportunities.

“While it would be better to capture 100% upside from rising prices, it is prudent for us to take away the risks associated with a warmer-than-normal winter, a longer lasting impact from COVID, and higher-than-expected oil prices,” he explained. “While initiating forward hedges, we take a surgical approach aimed at targeting the higher-risk seasonal periods, resulting in more risk protection in the volatile summer months, while leaving more upside in the winter months to be hedged over time.”