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Hedging Rush In U.S. Shale Could Send Prices Tanking

The U.S. shale industry could add yet another dose of new supply in July, with the EIA projecting production growth of about 127,000 barrels per day month-on-month. The fact that shale output is still growing at a rapid clip should raise some concerns about the trajectory of the “rebalancing” process.

The gains expected in July will come largely from the Permian Basin (+65,000 bpd) and the Eagle Ford (+43,000 bpd). While total figures are still uncertain, the production gains could put total U.S. output close to 9.4 mb/d in the relatively near future, only a few hundred thousand barrels shy of the all-time high.

(Click to enlarge)

Surging output would come even as oil prices have faltered recently, a worrying sign that shale drillers are going to continue to ramp up even if the market softens.

There are a few interesting trends to watch that could contribute to even higher output in the months ahead. First, U.S. shale drillers are much less hedged right now than they were in recent years. Operators typically secure hedges to lock in sales, allowing them to undergo a drilling campaign with some certainty. But, in the first quarter of 2017, a range of shale companies declined to hedge in hopes of allowing prices to rise. Reuters analyzed the disclosures of the 30 largest shale drillers and found that most passed on hedging in the first three months of the year, a marked difference from 2016, a time when oil prices were even lower. Related: Oil Prices Retreat On Rising OPEC Output In May

The failure of an oil price rally has likely left shale drillers a little more exposed to market prices, a risk that most would like to avoid. The portion of their unhedged output is about 20 percent larger than a year ago. As such, analysts told Reuters that many in the industry will probably try to lock in some hedges at the next possible chance, which could come if oil prices rise a bit.

If a rush of hedging takes place if oil prices rise to, say, $50 per barrel, it could offer some certainty and reassurance to embattled shale drillers. That, in turn, could allow them to drill more and boost production – a downside risk to oil prices towards the end of this year and into 2018.

Another trend to watch is the ongoing tweaks and innovations that have allowed shale drillers to survive in a world of $50 oil. One interesting development is the practice of returning to old wells for another bite at the apple. According to the Bismarck Tribune, shale drillers in the Bakken are returning to old wells and “refracking” them, which is exactly what it sounds like. Related: Does This $2.5B Bidding War Signal A Resurgence For Coal?

Drilling technologies and practices of today are superior to what the industry was using five, six or seven years ago. Oil companies are reportedly returning to wells drilled prior to 2010, refracking them and getting much more oil out than the first time around. “On average, they’re getting better performance from the wells,” Justin Kringstad, director of the North Dakota Pipeline Authority, told the Bismarck Tribune. Of the 140 wells that have been refracked in the Bakken, Kringstad says that most saw a jump in production from 200,000 to 250,000 barrels. One of the key differences in drilling practices in the intervening years since the wells were originally drilled is the heavier use of sand and water in the fracturing process.

Refracking is probably not a game changer that would lead to a tidal wave of new production. But it does highlight one of the ways in which drillers are squeezing more oil out of wells than they could have in years past. That ultimately means lower breakeven prices and higher output. At the end of the day, that is bearish for oil prices.

That is not to say that oil prices are destined to fall. Many analysts still argue that global demand is outstripping supply, which will result in an accelerated drawdown in inventories for the remainder of the year. But the fact that shale drillers continue to defy expectations, ratcheting up output even as prices languish at or below $50, should give oil watchers pause. Even OPEC acknowledged its disappointment in its latest monthly report, stating that the oil market was rebalancing at a “slower pace” than it had expected. The group pointed the finger at “the shift in U.S. supply from an expected contraction to positive growth.”

By Nick Cunningham of Oilprice.com

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  • Ness on June 14 2017 said:
    So what happens if oil stays in $45 range??? Do they finally cut capex and slow down, or keep pumping and just print shares to stay alive? You would think they would have figured out by now the market will buy them once they cut capex and production

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