The Gulf Today - Business - - SPECIAL REPORT -

NEW YORK: Many top US shale oil pro­duc­ers are miss­ing out on the rally in oil prices to more than $70 a bar­rel - be­cause they sold their oil through fu­tures con­tracts at about $55 last year when that looked like a good deal. Now, it looks cheap.

Those hedged bets will hold down rev­enues and fur­ther frus­trate Wall Street in­vestors, who have been dis­ap­pointed by slow re­turns from the boom­ing Per­mian Basin in west Texas.

The top 25 shale pro­duc­ers will forego about $1.7 bil­lion in com­bined rev­enues in the sec­ond quar­ter with oil prices at about $70, ac­cord­ing to Den­ver-based con­sul­tancy Petronerds. Many of those pro­duc­ers used hedges that guar­an­teed them be­tween $55 and $58 a bar­rel.

Some west Texas pro­duc­ers face a sec­ond profit-lim­it­ing dy­namic: They are forced to cut prices be­cause the re­gion’s pro­duc­tion is over­whelm­ing its pipe­line net­work, rais­ing trans­porta­tion costs.

West Texas oil cur­rently trades at a dis­count of $9 to US bench­mark fu­tures, a spread that hit $12 ear­lier in the month.

Some firms ear­lier pro­tected them­selves from the widen­ing gap with hedges against the dis­count.

But those that didn’t - and also hedged against fu­ture prices at, for in­stance, at $55 - have been forced to sell bar­rels at prices in the low-to-mid $40s.

Oc­ci­den­tal Pe­tro­leum Corp, the big­gest oil pro­ducer in the Per­mian, hedged us­ing west Texas crude fu­tures priced at about $59 a bar­rel, ac­cord­ing to first-quar­ter reg­u­la­tory fil­ings. The com­pany did not hedge against the Mid­land dif­fer­en­tial.

Oc­ci­den­tial, which pro­duces about 226,000 bar­rels per day (bpd) from the Per­mian, de­clined to com­ment on its hedg­ing strat­egy. It could off­set softer drilling rev­enues with bet­ter re­sults from its pipe­line unit, which ben­e­fits from the ris­ing trans­porta­tion costs.


Many firms sold their fu­ture out­put at prices in the $50s last year, hoping to take ad­van­tage of short-term ral­lies to lock in guar­an­teed in­come to cover drilling and pro­duc­tion costs. Those costs can be $30 a bar­rel or less in west Texas, al­low­ing the firms a healthy profit even as they pro­tected them­selves against fu­ture price slumps.

But the cost of that pro­tec­tion is to forego the po­ten­tial up­side of higher prices.

The sec­ond prob­lem, with pipe­line ca­pac­ity, stems from sur­pris­ingly quick pro­duc­tion growth that has pushed pipe­line ca­pac­ity to the limit sev­eral months be­fore pro­duc­ers ex­pected, said Michael Tran, global en­ergy strate­gist at RBC Cap­i­tal Mar­kets.

Pro­duc­ers in west Texas, the na­tion’s largest oil­field, are now pump­ing more than 3.3 mil­lion bpd, com­pared with 2.4 mil­lion bpd a year ago. With stor­age brim­ming and pipe­lines full, pro­duc­ers have had to of­fer steep dis­counts to com­pen­sate for ris­ing trans­port costs.

The large gap be­tween the US fu­tures price and Per­mian Basin oil is called the Mid­land dif­fer­en­tial named for the town at the cen­tre of the west Texas oil­field boom.

Un­til re­cently, firms had not hedged the dis­count be­cause the price of Mid­land oil and US fu­tures have his­tor­i­cally tracked closely to­gether. The mar­ket for such hedg­ing is also less ac­tive, com­pared with fu­tures hedg­ing.

But at the end of the first quar­ter, 14 shale com­pa­nies had hedged against 100 mil­lion bar­rels of 2019’s pro­duc­tion in West Texas, com­pared with just 40 mil­lion bar­rels at the end of the fourth quar­ter, ac­cord­ing to a Reuters Anal­y­sis of US reg­u­la­tory fil­ings.

“It’s re­ally be­com­ing a more widely used phe­nom­e­non,” said Ben Mon­tal­bano, Petronerds co­founder, who said Mid­land hedg­ing vol­ume has in­creased ten­fold in the last two years.

Com­ing into this year, Ci­marex En­ergy Co had hedged about 905,000 bar­rels of 2019 west Texas pro­duc­tion at a 47-cent dis­count to US bench­mark fu­tures. That means if US oil fu­tures trade at $70 a bar­rel, Ci­marex would sell oil at $69.53 - as op­posed to com­pa­nies that didn’t hedge, and are ex­posed to the en­tire Mid­land dis­count, now at $9.


In the first quar­ter, Ci­marex in­creased its hedge against the dif­fer­en­tial to 3.1 mil­lion bar­rels, ac­cord­ing to the firm’s fil­ings. About half of that, how­ever, was hedged at a less fa­vor­able dis­count of $4.83 per bar­rel - ef­fec­tively sell­ing oil at $65 if fu­tures are at $70. Ci­marex pro­duced about 50,000 bpd in the Per­mian in the first quar­ter. The com­pany did re­spond to a re­quest for com­ment. With ma­jor pipe­lines not ex­pected to come on­line un­til next year and pro­duc­tion in­creas­ing, an­a­lysts ex­pect the Mid­land dif­fer­en­tial to re­main high. Oc­ci­den­tal, in a re­cent pre­sen­ta­tion, said it ex­pects this gap to hit $20 a bar­rel by the third quar­ter.

“For the first time in three years, we have not had a pipe­line to come on to al­le­vi­ate the bot­tle­neck,” said Tran.

Some firms, in­clud­ing Apache Corp and Pi­o­neer Nat­u­ral Re­sources, said they don’t have to worry about the dif­fer­en­tial be­cause they have re­served enough space on pipe­lines to trans­port their oil.

Apache said it has started to hedge its Mid­land ex­po­sure for 2019. Pi­o­neer does not have any such po­si­tions, said Rich Dealt, CFO.

“Pi­o­neer has firm trans­porta­tion in place over the next few years to move nearly all of its Per­mian Basin oil pro­duc­tion to the Gulf Coast for ex­port or sale to re­finer­ies,” Dealt said.

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