Shale oil drillers in the United States are set to report strong financial results for the third quarter, but there's a catch: only those who didn't hedge their production earlier will enjoy the windfall.
Reuters' Liz Hampton wrote this week that oil producers who didn't hedge their output stand to reap the benefits of an 80-percent jump in U.S. crude oil prices, which during the third quarter averaged $71 per barrel.
According to Hampton's report, non-hedgers such as Pioneer Natural Resources and Continental Resources will likely report solid earnings increases for the third quarter. Meanwhile, hedgers such as EQT Corp are expected to report losses.
The hedging problem of U.S. shale drillers is not a new one. Early this year, as West Texas Intermediate reached $70 per barrel, IHS Markit calculated that those producers lost billions because they hedged their output at $55 per barrel.
For the first half of 2021, IHS Markit said in July, losses reached $7.5 billion, but if oil prices remained around $75 per barrel, this could add another $12 billion during the second half of the year as demand continues to improve. Currently, WTI is trading at well above that, at $83 a barrel, which means those that hedged unwisely are in for even greater losses by the end of the year.
Even so, in July there was a rush among U.S. shale producers to hedge production amid uncertainty about OPEC+'s next move with regard to production. At the time, there was a rift between Saudi Arabia and the United Arab Emirates that sparked fears of the cartel potentially breaking down and increasing production, pressuring oil prices. This was what prompted the hedging rush.
Since then, however, OPEC+ has overcome its internal divisions and is once again calling the shots, which for the observable future appears to be focused on letting prices run as high as possible. This will likely affect shale producers' future hedging decisions as the end of the year approaches, but just how much it will affect them remains to be seen.
The situation remains highly uncertain. While OPEC+ officials have repeatedly signaled and openly stated that they will stick to their cautious approach to returning more production to the market, calls for more barrels are likely to grow as buyers grapple with ever-higher prices. This means that the cartel could at any moment decide to change tack and boost production by more than initially planned, which would weaken prices and hurt the non-hedgers.
Clearly, not all share drillers can be happy at the same time. Hedging is, ironically perhaps, risky business. Pioneer Natural Resources, for instance, suffered hedging losses for the second quarter. It hedged again and has now reported hedging losses of $501 million. For the first nine months of the year, Pioneer's hedging losses have topped $2 billion. Even so, expectations are that its net earnings per share would rise to $3.94 from $0.17 a year earlier in a sign that it's not so much about hedging itself as the extent to which you hedge that is important.
"The only thing that is going to be preventing a blowout quarter is the hedging situation," one equity research analyst told Reuters' Hampton.
While it may not be a blowout, the quarter will still be strong for U.S. shale drillers, with free cash flow seen strong despite hedging losses. According to Enverus, the 64 shale oil companies that it tracks could report a combined free cash flow of $11.9 billion for the quarter but will have to write off a third of that because of hedging losses. Still, not too shabby to have some free cash flow. After all, this hasn't always been the case for U.S. shale oil.
By Irina Slav for Oilprice.com
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Irina is a writer for Oilprice.com with over a decade of experience writing on the oil and gas industry. More