(Bloomberg Gadfly) – Liam Denning
I know the year’s barely started, but it’s already time to start thinking about 2019.
The reason is the oil rally that has taken West Texas Intermediate back above $60 a barrel; Brent to about $70; and analyst chatter to the rarefied realm of $80. Focusing in on WTI, there’s been a big shift in the futures curve over the past six months:
I wrote here last month about the surge in hedging by North American exploration and production companies during the third quarter of 2017. At the end of June, 53 firms analyzed by Bloomberg New Energy Finance had collectively hedged about 636,000 barrels a day, or 12 percent, of their expected oil production in 2018. Three months later, that had risen to more than 1.5 million barrels a day, or 29 percent, with hedging weighted toward the first half of 2018 in particular.
Hedging for 2019 was still relatively scarce, though: As of the end of September, only 200,000 barrels a day, around 3 percent, of expected oil production was hedged, according to BNEF’s database. That isn’t unusual; you wouldn’t really expect E&P companies to be hedging a lot of production 18 months or more in the future.
Now that New Year’s Day 2019 is less than 12 months away, though, E&P companies may well be considering locking in hedges for next year, especially in light of that recent rally.
Swaps for 2019 are now around $57.50 a barrel, almost $8 a barrel higher than where they traded in the third quarter, and with almost half that gain coming in the past month alone.
Those eight bucks are significant, equivalent to the average cost of infrastructure and corporate overhead per barrel for the top 30 producers in the Permian basin, according to a presentation given in November by Rystad Energy’s VP of analysis, Artem Abramov. He pegged the averaged full-cycle cost there at about $54 a barrel.
Meanwhile, the average prices locked in by Permian operators via hedges in the third quarter were about $49 for 2018 and about $52 for 2019. It should also be noted that current swaps prices are higher than where they were in late 2016 and early 2017, when E&P firms rushed to hedge last year’s output in the initial celebratory period after OPEC first announced supply cuts.
The upshot being that $57.50 represents an attractive point for E&P companies to start locking in hedges for 2019 already.
There are some clues suggesting this is happening. The net short position of swaps dealers in WTI crude oil futures and options — a proxy for E&P hedging — has expanded by a notional 250 million barrels since the end of the third quarter, with that trend continuing into 2018.
Meanwhile, energy economist Phil Verleger noted in a recent report that open interest in the three main crude oil futures contracts expiring in more than one year stands at 1 million contracts (a notional billion barrels), versus just 800,000 contracts a year ago. The implication being that producers are locking in hedges on 2019 production more aggressively than they were doing for 2018 a year ago.
Verleger estimates this translates to an increase in U.S. oil production of at least 600,000 barrels a day in 2019, which is slightly higher than the initial projection from the Energy Information Administration, released earlier this week.
We won’t get the full picture until both fourth-quarter and first-quarter earnings are out of the way, roughly by the beginning of May. It seems likely that E&P companies will have taken the opportunity to take some risk off the table for 2019. If it turns out they haven’t, then that would imply some pretty bullish thinking about the oil market next year.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.