NEW YORK (Reuters) – Three years after a ban on crude oil exports was lifted, some U.S. shale producers are doing something they have never done before – lock in prices for their barrels that will find a home overseas.
Shale companies, primarily those operating in the Permian basin, the biggest U.S. oilpatch, are finding new ways of insulating themselves from the wide discount of U.S. West Texas Intermediate crude futures (WTI) to the global benchmark Brent WTCLc1-LCOc1.
In the second quarter, as WTI’s discount to Brent whipsawed and widened to the most in over three years, WPX Energy Inc (WPX.N), SM Energy Co (SM.N) and Oasis Petroleum Inc (OAS.N) began quietly erecting specialized hedges, a Reuters analysis of company filings found.
The hedges, the first of their kind for these producers, protect against that discount widening as their oil increasingly gets sold to foreign buyers.
The hedged volumes are relatively small, but indicate the rising importance of export revenues as the U.S. plays an increasingly dominant role as a global oil supplier.
U.S. oil production is near a record 11 million barrels per day (bpd), depressing the price of WTI versus Brent, while also spurring an export boom. Since the lifting of a 40-year ban in 2015, crude exports surged to as much as 3 million bpd in June.
Traders closely watch the spread between the two benchmarks to gauge export economics. While a wider discount makes U.S. oil attractive to foreign buyers, for producers, it means weaker revenues. Locking the spread in protects export-related revenues.
LOOKING TO WORLD PRICES
Permian producers have long protected future revenue through financial instruments, but they have typically been solely linked to WTI. That is changing, according to filings and interviews with brokers, bankers, hedging consultants and company executives.
“Previously, all of our sales would be really tied to domestic indices,” said Todd Scruggs, vice president and treasurer of WPX Energy. “The fact that we can have our barrels sold internationally is a new thing – and we’re happy to take advantage of that.”
Companies identified a price – in this case for WTI to trade at a discount of around $8 a barrel to Brent – and use contracts known as “basis swaps” to lock in prices at that level. Basis swaps have become popular among Permian producers to manage the spread between regional oil prices in West Texas against U.S. futures. But now companies are using the swaps to hedge Brent versus WTI.
In the second quarter, WPX used Brent-WTI basis swaps to hedge 3,000 bpd of 2020 production at a $8.40 WTI discount to Brent. If two years from now, Brent trades at $90 a barrel and WTI at $80, WPX’ effective price will be $81.60.
“When we lock in the Brent-WTI spread, we’re effectively ensuring that the sales arrangements that we’ve made will stay in the money going forward,” said Scruggs.
WPX, however, could be exposed if that spread were to contract to a level narrower than the fixed price.
WTI currently trades at about $9.35 below Brent. During the second quarter, the spread went from about $4.50 to as much as $11.57.
U.S. SHALE EXPORTS RISE
This hedging practice is likely to gain prominence given rising U.S. crude exports and shale producers looking to capture the higher prices available on world markets, said John Saucer, a vice president at advisers Mobius Risk Group.
SM Energy hedged about 1.29 million barrels for 2020 at a $7.97 discount, with additional volumes hedged through 2022. An SM Energy spokeswoman said such swaps are a small component of its overall hedging strategy.
SM Energy’s basis swaps cover a portion of its Midland production “with sales contracts that settle at ICE Brent prices,” according to a securities filing.
Oasis Petroleum hedged 153,000 barrels, or nearly 3 percent of 2018 production, at a $10.50 differential and slightly more volumes in 2019 at the same price. The company, which did not respond to requests for comment, recently acquired acreage in the Permian and operates in North Dakota’s Bakken region.
There may be soon be more efficient ways to lock in prices for oil exports as new Gulf Coast futures, which are based on pricing in Houston rather than at the Cushing, Oklahoma, storage hub, are launched.
However, infrastructure bottlenecks at U.S. coastal ports could cap exports, keeping WTI depressed.
“Banks are making a big push to offer differentiated hedging solutions,” said Michael Tran, commodity strategist at RBC Capital Markets.
Reporting by Devika Krishna Kumar and Ayenat Mersie in New York; Editing by Marguerita Choy