Oil Industry Not Hedged For 2018

Friday March 24, 2016

In the latest edition of the Numbers Report, we'll take a look at some of the most interesting figures put out this week in the energy sector. Each week we'll dig into some data and provide a bit of explanation on what drives the numbers.

Let's take a look.

1. Global CO2 emissions flat for 3rd Year in a row

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- Even as global GDP grew, global CO2 emissions held steady for a third consecutive year in 2016, according to the IEA. Economic growth continues to slowly decouple from fossil fuel consumption.
- Global emissions in 2016 were flat at 32.1 gigatonnes, more or less the same as in 2014 and 2015, even as global GDP expanded by 3.1 percent.
- Emissions fell in China and the U.S., the world's top 2 emitters, while CO2 emissions in the EU were flat. That offset the rise in carbon pollution from most of the rest of the world.
- The decline can largely be attributed to the shuttering of coal-fired power plants in favor of natural gas and renewable energy.
- Renewable energy in 2016 accounted for more than half of the capacity additions for the year.

2. Venezuela running out of cash

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- Venezuela's foreign exchange continues to dwindle, even though oil prices moved up into the $50s per barrel between November and March.
- Venezuela's deep economic crisis continues to worsen. State-owned PDVSA lacks adequate funds to import the light oil needed to dilute heavy oil from the Orinoco heavy oil belt.
- With cash standing below $10.5 billion, the Venezuelan government is teetering. Some traders put the chance of default at roughly 50 percent this year.
- PDVSA has about $2 billion in cash while $10 billion in debt payments this year.
- Venezuela pledged to cut oil production by 95,000 bpd as part of the OPEC deal - a cut that will likely come anyways because of the decrepit state of Venezuela's oil industry. In fact, a steeper fall is possible this year.

3. Oil investors losing faith in $50 oil

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- Hedge funds and other money managers slashed their net-long positions on WTI by 87 million barrels in mid-March amid growing concerns about the health of the market.
- Having built up the most bullish position on record, the lop-sided bet was bound to come undone at some point. The liquidation of the astounding net-long position began about two weeks ago and could continue.
- That has corresponded with a more than 10 percent decline in oil prices.
- The ratio of long to short positions stood at roughly 4:1 for the week ending on March 14, the lowest ratio since the OPEC deal was announced. That was down sharply from the nearly 9:1 ratio seen in early March, just ahead of the liquidation.
- The unwinding of the bullish bets and the return of pessimism could push oil prices down further. The flip side of that argument is that with some of the heat let out of the market, there is less room to fall, possibly setting oil up for another round of stability, albeit at lower price levels.

4. Shale earnings down sharply from past years

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- Rig counts are rising quickly and shale companies are drilling new wells. Lower breakeven prices have allowed the shale industry to rebound quickly.
- But oil margins per barrel of oil produced by 11 shale companies analyzed by Bloomberg Gadfly have declined by nearly 75 percent between 2014 and 2016.
- The 11 E&Ps surveyed are earning just about $7.40 dollars per barrel of oil equivalent, which takes into account not just production costs, but also interest payments on debt, administration costs, as well as lower realized prices than the prevailing benchmark oil price (some companies sell more natural gas than oil).
- Bloomberg Gadfly concludes that the enormous level of production even at these low margins is a testament to the "remarkable faith of…equity markets in a brighter future." Without Wall Street, there were would be a much bigger "shake-out in the industry."

5. Frac sand demand on the rise

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- Frac sand producers saw their stock prices soar following the OPEC deal, on expectations of a revival in drilling demand.
- On top of that, shale drillers are using more and more sand in every well, with the average volume of sand per drilled well nearly doubling over the past five years to 1,400 pounds per lateral foot.
- In the Permian, drillers pump about 1,700 pounds of sand per lateral foot down each well on average, up from 1,200 pounds two years ago.
- On the other hand, more oil is being squeezed out of each well, meaning less wells are needed.
- So frac sand demand is actually down in absolute terms over the past two years despite the rise in the amount of sand used per well.
- Looking forward, however, sand demand will rise strongly as drilling picks up.

6. EV sales off to strongest start yet

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- Low oil prices and an oil and gas friendly White House raised fears that the growth of electric vehicles would stall out. But the start of 2017 has been the industry's best yet.
- 2016 was a record year, and if this trend continues 2017 will break last year's record.
- More EV models are set to hit dealers this year, including the Chevy Bolt and the much-anticipated Tesla Model 3, both of which are (relatively) affordable at roughly $35,000. More options will likely lead to an increase in sales.
- Moreover, a collection of U.S. cities are in discussions to make bulk purchases for municipal fleets, as reported by Bloomberg.
- L.A, New York, Chicago and others are considering the purchase of 114,000 EV cars and trucks, a sale that could be worth as much as $10 billion.

7. Oil companies insulated with hedges. But not for 2018

- The oil industry has made extensive use of hedging during the three-year oil bust, which has protected them from the periodic dips in oil prices.
- Most oil producers have hedged a portion of their production for 2017. Small and midcap producers have 53 percent of their oil production hedged this year and 74 percent of their gas.
- The largest oil companies have only 28 percent of their oil production hedged.
- But next year, the industry is much less protected. Small and mid-cap producers only have 19 percent of their 2018 production locked in. The large-cap producers have just a paltry 3 percent of their production hedged.
- Unless oil prices rebound - something that is looking less likely - the industry will have to either go without production or lock in hedges at relatively low prices.

That's it for this week's Numbers Report. Thanks for reading, and we'll see you next week.