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North American E&Ps Facing Year With Few Hedges

U.S. and Canadian producers have hedged only 15% of total oil and natural gas volumes for 2016 and 5% of their volumes for 2017, which may leave them even more exposed to depressed prices.

Raymond James & Associates Inc. on Monday said at this time a year ago, U.S. exploration and production (E&P) companies had about 30% of oil and gas volumes hedged. Today, the same group of E&Ps only has about 15% of total volumes hedged for 2016 and 5% hedged for 2017, the lowest level in a decade and well below the 40% of total output that was hedged in 2014.

The decline in hedging now is exacerbated by the collapse in oil and natural gas futures prices this year, said analysts John Freeman, Kevin Smith and J. Marshall Adkins. Less hedging likely will contribute to "meaningful" cash flow and spending reductions for the domestic E&Ps.

Last year's hedging gains played a role in helping to prop up overall cash flows, according to Raymond James. Hedges accounted for about 17% of U.S. E&P estimated earnings before interest, taxes, depreciation, depletion, amortization and exploration expenses, otherwise known as EBITDAX. For smaller operators, about 17 covered E&Ps with less than 100,000 boe/d of output, 38% of their EBITDAX last year was attributed to hedging gains.

"This phenomenon is another compounding factor -- along with E&P leverage concerns and the dire oil price environment -- that will result in depressed cash flows and severe capital expenditure cuts in 2016," Freeman said.

IHS Inc.'s energy group also reviewed overall hedging for a group of 51 North American E&Ps. IHS Energy's "Comparative Peer Group Analysis of North American E&Ps," issued late last month, found that the U.S. and Canadian producers had hedged only 15% of total output this year. Oil and gas volumes hedged is set to fall even more in 2017, with only 2% of oil volumes protected and 7% of gas.

"Companies hedge their production to provide a level of protection against oil and gas price fluctuations, and in 2016 and 2017, we see a significant decline in hedging protections, which means more companies are exposed to the current depressed prices and market conditions," said IHS Energy's principal analyst Paul O'Donnell, who authored the analysis. "For most companies in the sector, 2016 is going to be another very tough year, as plunging revenues lead to balance sheet deterioration and financial pressures mount."

Smaller E&Ps have the highest level of hedging protection, according to IHS, with 47% of oil production covered at $74.31/bbl and 46% of gas production at $3.43/Mcf. By comparison, the small E&Ps in 4Q2015 had hedged 77% of their oil at $83.15/bbl and 58% of gas at $3.67/Mcf.

Midsize domestic E&Ps have 43% of oil output protected at $60.54/bbl and 26% of the gas hedged at $3.34.

Large domestic E&Ps, by contrast, have hedged only 6% of oil at $53.85, with 16% of the gas output hedged at $3.58, "making them the most exposed of the U.S. peer groups," O'Donnell said. "The majority of companies in this group are unhedged in 2016 and 2017, although their balance sheet strength is superior to that of their smaller counterparts, offering a bigger financial cushion."

Meanwhile, Canadian E&Ps had hedged about 9% of oil production at C$78.54/bbl and C$3.87/Mcf of gas, IHS calculated.

Jason Wangler of Wunderlich Securities Inc. last month noted that the problem is not so much hedges from 2015 rolling off, but the "good/higher priced hedges" were rolling off.

"We firmly believe that hedging going forward could give us a good window in the current (and future) economics of plays and companies," Wangler said. "With so few players, if any, making money at today's oil and natural gas prices, we are not surprised that hedging activity is so muted. That said, we will be very interested going forward in when, and at what price, companies hedge their oil and natural gas as we think it could help provide a window into the economics of plays (and companies) especially as the hedges wear off assuming prices remain low."

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