Figure - expiring hedges

Some major US shale producers may be vulnerable to WTI crude oil prices below $50, even with the benefit of their present hedges, new analysis from the Carbon Tracker Initiative (CTI) shows.

What oil price will they need next year, after their present hedges expire, and these companies are more exposed?

The CTI analysis, which I co-authored, investigated five major shale independents, and made three conclusions.

First, it found that at sustained oil prices below around $50 a barrel, some companies such as Whiting Petroleum would approach debt covenants agreed under their senior credit facilities. Chesapeake appeared sensitive to oil prices below $50 combined with gas prices below $2.25 per mcf.

These covenants are lines which creditors expect companies not to cross. This was a static, illustrative analysis. In the real world, options for evasive action not to exceed covenants would include capital raisings, or a re-negotiation with creditors. But the findings illustrated their sensitivity to lower oil and gas prices.

Second, oil hedges at all five companies will decline this year, and expire altogether for most (see chart below).

The hedges will protect the companies in 2015, raising around $1.2 billion in the case of Chesapeake, for example. The question is how companies will replace such revenues in 2016, given any replacement hedges will be at less attractive prices (perhaps around $60 compared with $75-95 this year).

And third, investors have backed the sector with a record amount of capital so far this year.

The first quarter and the month of March were both records for public equity offerings, by U.S. exploration and production energy companies. And as of April 30 they had issued some $18 billion in high yield bonds, compared with $36 billion outstanding for the whole of last year.

What does it all mean? Even with the benefit of hedges, some shale companies are sensitive to oil prices below $50. What will the oil price have to be next year, after their hedges expire? Investors should be aware that these relatively high-cost producers have still not felt the full effect of lower commodity prices.

Figure. Crude oil hedges above $58 WTI price floor, quarterly volumes, 2015-2016

Figure - expiring hedges

Sources: Company annual reports and presentations; CTI analysis

 

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