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Tsvetana Paraskova

Tsvetana Paraskova

Tsvetana is a writer for the U.S.-based Divergente LLC consulting firm with over a decade of experience writing for news outlets such as iNVEZZ and…

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How Oil Hedging Could Cost Companies $7 Billion

The recent oil price rally has been a boon for U.S. oil producers, but for those that have hedged future production at prices capped below current oil price levels, hedging contracts could result in US$7 billion in losses if WTI prices were to stabilize at $68 a barrel this year, Wood Mackenzie analyst Andrew McConn told Bloomberg in an interview.

Oil hedging during the downturn resulted in gains for those companies, as producers were hedging barrels at higher-than-market prices to lock in future production and insulate against the low oil prices. Between 2015 and 2017, companies generated US$23 billion in gains form hedging, according to Wood Mackenzie.

But now hedges at prices capped below current full-market prices are generating losses for some companies.

“Basically, every company is going to lose a significant amount of upside exposure if prices stay where they are now,” McConn told Bloomberg.

Last week, Hess Corp said that it had spent US$50 million to unwind hedges that capped its sales at $65 a barrel WTI, while prices have been above that, at around $67 on Wednesday. According to McConn, Hess will likely have company with other producers also set to pay for unwinding hedges.

With WTI at current levels, hedging contracts capped at $65 or below are now a drag on company sales instead of the lifeline they were during the oil price slump.

WoodMac’s McConn analyzed 33 companies, including Hess, Anadarko Petroleum, Pioneer Natural Resources, and EOG Resources. Of all companies, only three had such hedging contracts that would raise their revenues this year by 1 percent, and eight firms are expected to generate losses from hedging. Related: Oil Prices Spike As OPEC Compliance Hits New Record

According to WoodMac, most companies hedge around 30 percent of their oil production on average, so they have enough production to sell at full-market price and book gains when oil prices are rallying.

Estimates by Bloomberg New Energy Finance, based on analyst production estimates and company filings, showed that the most-hedged company for 2018 by percentage of crude oil production was Parsley Energy with 97 percent production hedged, followed by Laredo Petroleum and WildHorse. EOG Resources is the least hedged, with 9 percent of production hedged.

Still, hedges will not necessarily lead to losses as WTI prices are not expected to average $68 a barrel or more this year. For example, according to the latest monthly Reuters poll of analysts and economists, the U.S. benchmark is now expected to average $63.23 a barrel this year, up from $59.85 in the March poll.

By Tsvetana Paraskova for Oilprice.com

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