Poor Hedging DecisionsTrevali is not the only company losing money on hedges. It is a big problem in the oil business.
https://oilprice.com/Energy/Crude-Oil/Shale-Giants-Hit-Hard-By-Poor-Hedging-Decisions.amp.html
Shale Giants Hit Hard By Poor Hedging Decisions
By David Messler - Aug 02, 2021, 7:00 PM CDT
The lack of growth in shale production, currently inching higher but primarily from DUC- Drilled but Uncompleted wells, has been largely attributed to capital discipline. Shale companies have spoken almost in unison that the higher prices now being seen would not be enough to deter them from the balance sheet repair and shareholder returns strategy in lieu of growth that many embarked upon a year and a half ago. A factor that has not been widely reported is the level of hedging losses that are stripping away much of the upside presented by the current price scenario for WTI-West Texas Intermediate and Brent. In this article, we will look at the drivers for this strategy and what the impact may be to Pioneer and other shale companies that took similar steps.
Pioneer Natural Resources
Pioneer Natural Resources, (NYSE:PXD) sent a shockwave through the energy equity markets Tuesday with their pre-announcement of hedging losses to be booked for the second quarter. Pioneer, one of the largest Permian basin producers had hedged about 200K BOPD, about one-third of their daily production, at $40 per barrel. Their intent was to cushion a potential sell-off below that level, and guarantee they would stay in the black, thanks to their low break-even costs.
When prices for oil and gas moved higher as the year started, and then accelerated through the second quarter, the failure of this strategy becomes evident. The table above taken from the SEC-8K they filed on the 27th discloses hedging losses in excess of $1.5 bn for the first half of 2021.
Now to a company generating the kind of cash flow that Pioneer is, this isn’t the end of the world. But it does raise questions as to how such a bearish strategy was implemented when the trend for oil prices began to improve, though modestly by mid-year.
What happened?
Go back a year to July 2020. It was a vastly different world than the one that exists today. Many of us have forgotten how terrified we were. In the relative balmy period that has been operative since early November 2020 and the announcement of the vaccine efficacy, it’s been easy to forget that state of mind.
As noted in a Financial Times article, in those dark days of mid-2020, where the futures contract for WTI fell below $0.00 zero briefly, lenders were nervous about the viability of some companies and forced to them buy “insurance” against the wild fluctuations of the commodity. This insurance took a number of forms, but the most popular was to simply purchase a SWAP contract for future production.
SWAPS are a form of hedge that enables a producer to fix a price for their production in a particular forward month. If the settlement price is lower than the hedged price, then the producer books a hedging profit. If the inverse is true, then a loss is booked.
In PXD’s case, this insurance was provided by a series of SWAP contracts for various crude benchmarks, some of which had been taken out by companies bought by PXD-Parsley Energy, and DoublePoint Energy. With hedged prices in the low $40’s, when those contracts expired, PXD was forced to pony up the cash. A lot of it is shown in their 8K release.
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 roughly $50.00 per barrel. The good news is that they have much less production locked in at that price than in 2021.