US shale oil producers to return when low floor hedges expire

29 Jun 2021

Quantum Commodity Intelligence - The elasticity of US tight oil production will bounce back after the fourth quarter as the market shrugs off old low floor hedges, with losses this year mounting to around $15 billion in derivatives contracts for US oil companies, according to Rystad Energy.

Although US crude prices have doubled in the last year, the oil rig count has been slow to respond, with the numbers stuck on 373 for two weeks running, data from Baker Hughes showed this week. 

The connection between rising prices and production is far looser than it was three years ago, as independents focus on rebuilding balance sheets and returning capital to investors through special dividends. 

“This year is a bit special as the industry is losing around $15 billion on derivative contracts (before-tax),” said Artem Abramov, head of shale research at Rystad.  

“Next year the capex will increase organically as old low floor hedges expire.”

“Private exploration and production will likely build strong production momentum already by the fourth quarter (sustainable growth from first quarter 2022) as they already account for 50% of nationwide drilling activity, a record high.”

Analysis by BTU Analytics in the third quarter last year warned some independents would lose out on a rally in WTI because they had bought call options to protect against prices crashing again.

“As of 3Q 2020, a group of 29 publicly traded, independent E&Ps have about 27% of expected oil production hedged in 2021, compared to about 26% of 2020 oil production hedged as of 3Q19,” BTU analytics stated.

“A few operators, like Callon, Devon, Diamondback, and Pioneer, have drastically increased the percentage of expected production that has downside price protection than they had a year ago.”

Some 28 of these oil-focussed independents in the third quarter last year had call option protection for a protion of their production with an average ceiling price of $46.15/b.

“This means that producers may sacrifice significant upside if oil prices rally in 2021, given that WTI prices are currently trading just shy of $45/bbl,” noted BTU Analytics last year.

The US Energy Information Industry (EIA) estimated the US had 6,521 drilled by uncompleted wells (DUC) in seven major tight oil and gas basins in May, of which 2,616, or about 40%, were in the Permian basin. 

The number of DUCs peaked at 8,874 in June 2020, but the numbers then dropped around a quarter amid the collapse in oil demand during the pandemic. 

The shale industry needs a backlog of DUCS if they are to maintain or boost production levels because existing wells can see rapid declines in output.  

US shale output remains well below the January 2020 peak of 9.18 million bpd, with production from the seven largest fields this month running 7.7 million bpd, or 15.4% below that level, according to the EIA.