The lack of growth in shale production, currently slightly higher but mainly due to wells drilled but unfinished by DUC, has been largely attributed to capital discipline. The shale companies have said almost in unison that the higher prices currently seen would not be enough to deter them from the strategy of balance sheet repair and return for shareholders instead of the growth that many embarked on there. is one and a half years old. One factor that has not been widely reported is the level of hedge losses which suppress much of the rise presented by the current price case for WTI-West Texas Intermediate and Brent. In this article, we’ll take a look at the drivers behind this strategy and what the impact might be on Pioneer and other shale companies that have taken similar action.

Pioneer of natural resources

Pioneer Natural Resources, (NYSE: PXD) sent shockwaves through energy stock markets on Tuesday with their pre-announcement of second quarter hedge losses. Pioneer, one of the Permian Basin’s largest producers, had hedged about 200,000 BOPD, or about a third of their daily production, at $ 40 a barrel. Their intention was to amortize a potential sell below that level and ensure they would stay in the dark, thanks to their low breakeven costs.

PXD 8-K

When oil and gas prices rose early in the year and then accelerated through the second quarter, the failure of this strategy became evident. The table above taken from the SEC-8K they filed on the 27the discloses hedging losses greater than $ 1.5 billion for the first half of 2021.

Related: Analysts See Oil Trade Closer To $ 70 Through Year End For a company generating the kind of cash flow that Pioneer is, this isn’t the end of the world. But it raises questions as to how such a bearish strategy was implemented when the oil price trend started to improve, albeit modestly in the middle of the year.

What happened?

Go back a year to July 2020. It was a very different world than it is today. Many of us have forgotten how terrified we were. In the relatively mild period that has set in since early November 2020 and the announcement of the vaccine’s effectiveness, it has been easy to forget this state of mind.

As stated in a Financial Time article, in those gloomy days of mid-2020 when the futures contract for WTI briefly fell below zero $ 0.00, lenders were nervous about the viability of some companies and forced them to take out a “Insurance” against wild fluctuations in the commodity. This insurance took many forms, but the most popular was simply the purchase of a TO EXCHANGE contract for future production.

SWAPS are a form of hedging that allows a producer to set a price for their output in a particular forward month. If the settlement price is lower than the hedged price, the producer recognizes a hedge gain. If the reverse is true, then a loss is recognized.

In the case of PXD, this assurance was provided by a series of SWAP contracts for various crude benchmarks, some of which had been underwritten by companies purchased by PXD-Parsley Energy and DoublePoint Energy. With prices hedged in the $ 40 range, when those contracts expired, PXD was forced to fork out some cash. Much of it is shown in their 8K version.

In the case of PXD, there is good news and bad news. The bad news is that swap contracts are in place for their 2022 production at around $ 50.00 a barrel. The good news is that they have a lot less production stuck at this price point than in 2021.

How this will work to keep a lid on shale production

There is more pain to spread like the 2sd quarterly reporting season begins. According to Financial Time, there are about 30 oil and gas companies with significant hedging exposure in 2021 and 2022. Some widely owned shale names looking to hedge against a downturn include Devon, (NYSE: DVN), Diamondback Energy, (NYSE : FANG), Hess, (NYSE: HES), EOG Resources, (NYSE: EOG). However, none are as exposed to the magnitude of the losses suffered by PXD in terms of volume and price.

Related: Shell Reports $ 5.5 Billion Net Profit, Boosts Dividends

The impact of these drains on cash reserves will be to keep the trajectory of new shale production fairly flat. The focus on the balance sheet will prevent companies from borrowing to increase production. In their monthly schist newsletter, Rystad noted that only modest growth could be expected until the end of 2021.

“US crude oil production reached around 11.45 million bpd in June 2021. Despite the bullish conditions, it is only expected to increase by 60,000 bpd to reach 11.51 million bpd in July, remaining at the same level in August. A steady, albeit slow, growth path will begin in November 2021, when crude production is expected to return to 11.55 million bpd, and then close the year with 11.62 million bpd in December. From January 2022, production will continue to increase, not exceeding the monthly average of 12 million bpd until October of the same year. “

Your takeaway meals

Shale companies are expected to hedge less after 2021, assuming prices stay in the current high range of $ 60 to $ 70. Scott Sheffield, CEO of Pioneer comments on how the hedging strategy will be changed –

“If you go back to the period 2012, 2013, 2014, the price of oil went from $ 80 to $ 100. So I think it would easily test those prices over the next few years. So we’ll probably do less coverage. If it hits that $ 75- $ 100 range, you’ll probably see us continuing to hedge at that point to protect those earnings, obviously, and support both the base dividend and the variable dividend, but not. as high as us. have done in the past.

Motley fool

In this scenario, as the demand for oil increases, there are a number of constraints on increasing oil production. The OPEC + countries are once again the back-up producers, able to pump and hold oil from the market according to conditions, thus fixing the world price. US shale producers have a number of disincentives to increase production beyond the additional amounts that largely follow declines in traditional wells.

These factors will tend to tighten supplies over the next year and support WTI prices above $ 70 and Brent prices close to $ 80 per barrel. Once low-priced hedges and swaps start to decline later and in early 2022, shale producers will then have sufficient cash flow to increase production, further increasing free cash flow through reduced costs. costs realized in recent years. .

The companies described above look attractive at current prices and are seeing gains in current trading.

By David Messler for Oil Octobers

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