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U.S. E&Ps Placing Bets on Oil, Natural Gas Prices for 2018 and Beyond, Says Goldman

U.S. oil and natural gas producers stoked their hedges in the final three months of 2017 and 2018 hedging is already above the historical average, according to Goldman Sachs & Co. LLC.

Based on data issued by exploration and production (E&P) companies during the 4Q2017 earnings season, 2018 hedged oil/liquids increased to 48%/35% from 30%/22% post-3Q2017.

“For natural gas, 2018 hedging rose to 47% from 40% post-3Q2017 results, remaining above the five-year season average of 44%,” said analysts led by Brian Singer.

The estimated 47% hedge for 2018 natural gas production “may actually understate the amount of production that is hedged in the minds of producers,” said NGI’s Patrick Rau, director of Strategy & Research. "We believe much of the expected gains in natural gas production in the U.S. this year will come from associated gas production, which of course can be an afterthought for producers.

“Not too many E&Ps are drilling the Permian Basin specifically for its natural gas yield, so any contribution they get from gas is gravy. The fact that crude oil prices are now $60/bbl-plus versus where they were just a few months ago is essentially locking in higher cash flows from associated production already."

The largest increases to 2018 oil hedging during the fourth quarter were by Anadarko Petroleum Corp., EOG Resources Inc. and Newfield Exploration Co. For gas, the most hedges were added by Anadarko, Continental Resources Inc. and EQT Corp., which gained through its takeover of Rice Energy Inc.

Based on announced budgets for 2018, E&Ps should be able to balance capital expenditures with cash flow at an average West Texas Intermediate (WTI) oil price of $56.50/bbl, according to Goldman.

The “near $58/bbl average hedged oil price for E&Ps would allow many to remain cash flow neutral if oil prices remain at current strip of around $60.”

Most of the E&Ps that have hedged are above 50% for 2018. More hedging increases in 2018 would help producers to instill capital discipline, reduce cash flow volatility and execute on planned guidance with an $50-60 WTI price, Singer said.

The Goldman team also is seeing the beginnings of 2019 production hedging, with 9% of oil output by covered E&Ps hedged at an average WTI price of $58/bbl.

A “meaningful portion” of oil output growth this year among the covered operators should be from operators that are well hedged, Singer said. Twenty-two covered E&Ps would supply around 38% of this year’s oil production, excluding natural gas-heavies, which are more than 50% hedged.

“In contrast, we see 18% of growth from two covered producers that are less than 10% hedged,” Occidental Petroleum Corp. and Continental, he said.

“We note that most E&Ps are hedged between $50-60 WTI for 2018, below our $72.50/bbl oil price forecast, resulting in hedging losses for the vast majority of our coverage,” analysts said. “When assuming $60 oil, closer to today’s strip, we still see little differentiation if oil prices average in this range…”

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