By Nicole Friedman And Erin Ailworth
Rocked by months of plunging crude prices, oil producers are
harvesting financial bets to raise, for some, much-needed cash.
Using specialized trades with nomenclature like "three-way
collars" and "butterfly spreads," producers have long used futures,
options and other financial contracts to help lock in minimum
prices for oil.
But after the drop in oil from more than $100 a barrel to about
$50 in a matter of months, some of these hedges have shifted from a
form of insurance to a source of income.
While hedges are typically held until they expire, some
companies are starting to close them out early, enabling them to
reap gains, sometimes hundreds of millions of dollars, bankers and
traders said. Others are adjusting hedges to better protect
themselves against possible further price drops.
Carrizo Oil & Gas Inc. had placed several hedges on roughly
12,100 barrels a day that guaranteed it at least $91 a barrel, on
average. The company has already locked in a gain of $166.4 million
from those hedges, more than its total revenue of $163.3 million
last quarter, which it will collect as the hedges expire this year
and next. Carrizo also added new contracts guaranteeing a minimum
price of $50 a barrel for some of its oil this year and next,
protection in case oil prices, as some analysts predict, fall
further.
"We did this because we wanted to lock in the value we have in
that asset," said Jeffrey Hayden, vice president of investor
relations at Carrizo. The company didn't immediately need the cash,
he said.
Craig Breslau, managing director at French bank Société Générale
SA, said companies noticeably picked up activity this year. "We're
seeing a lot more restructuring or termination of hedges in the
early part of this year than we did in the fourth quarter of last
year," he said.
On Thursday, oil for May delivery gained 4.5%, to settle at
$51.43 a barrel, on the New York Mercantile Exchange. The price of
crude has plunged 52% since a high hit in June, as the shale-oil
boom in the U.S. has led to increased production and a surfeit of
supply.
Taking the money now and putting new contracts in place "could
very well be a smart move," said Thomas Heath, president of trading
and financial firm ARM Financial, which helps about 90 oil
producers hedge. "As long as you keep the hedge, you're not
gambling."
Some producers are restructuring hedges at the behest of their
lenders, which want companies to pay down debt or move hedges from
the next six months to later in the future, said Paul Smith, chief
executive of energy-advisory firm Mobius Risk Group in Houston.
Oil companies are still making money from the oil and natural
gas they sell, but many need additional cash to make debt payments
from rapid expansion over the past several years and cover
operating costs amid the decline in crude prices.
Cashing out of hedges provides a one-time windfall but could
leave producers in a tight spot if oil prices remain in a prolonged
slump as many market watchers expect. Companies are also
potentially leaving money on the table if they take profit on
contracts but then oil prices fall further.
And the move can be unpopular with shareholders, who may be wary
of oil companies that are forgoing protection against another leg
down in prices in exchange for money now. And companies are
notoriously bad at choosing when to put on and take off hedges.
"If a company has put on hedges...we would like to see that
remain in place, rather than using that to take a bet on oil
prices," said Matt Sallee, a portfolio manager at Tortoise Capital
Advisors LLC in Leawood, Kan., who said he prefers exposure to
well-hedged companies for this $17.5 billion fund.
Though many U.S. oil companies, especially smaller producers,
routinely use hedges to lock in prices, many were less hedged than
usual heading into the oil-price plunge that started in June.
Companies were reluctant to hedge last year because a quirk in the
futures market made oil prices in 2015 and 2016 much lower than
2014 prices. Producers reasoned that near-term prices would hold at
about $100 a barrel, as they had for three years, meaning that the
low prices offered in the market in future years weren't worth
it.
Producers typically hedge about half their output for a calendar
year by the end of the prior year. On average, producers have
hedged 31% of their 2015 production at an average price of $83.80 a
barrel and 11% of their 2016 production at $79.63 a barrel,
according to investment bank Simmons & Co. International, which
tracks about 40 producers.
Oklahoma City-based Continental Resources Inc. saw its share
price hammered shortly after it dropped nearly all its oil hedges
when crude was still priced at about $80 a barrel in early
November. The oil company earned $433 million from the move, which
was unanimously approved by its board, and it used the cash to
cover operating costs and keep its investment-grade credit rating,
Chief Executive Harold Hamm said in an interview in late February.
Continental reported $1.3 billion in revenue in the last
quarter.
Continental had previously locked in prices as far out as 2016,
and the company left tens of millions of dollars on the table by
cashing out when it did. But "that wasn't when we needed the
money," Mr. Hamm said. "We need it now." Continental's stock has
dropped about 23% since Nov. 3.
Cashing in hedges is part of the survival strategy being used by
Energy XXI Ltd., which booked a $377 million loss in its fiscal
second quarter ended in December after taking on nearly $1 billion
in debt to buy a rival last summer. The Houston-based company got
$73.1 million in January and February for cashing in some of this
year's hedges. The company also put on new hedges at lower prices
and increased the percentage of production hedged.
"We basically did it to give us some protection on the downside
and still have some room on the uptick if oil happens to run," said
a spokesman.
During an earnings call last month, Energy XXI Chief Executive
John Schiller Jr. said the company has been focused on cost savings
and low-risk projects. The company didn't respond to requests for
comment.
Similarly, Austin, Texas, producer Parsley Energy Inc. said it
brought in $63 million in the past few months by cashing in a
portion of its hedges. The company also put on new hedges at lower
prices. Parsley Energy declined to comment.
Some oil companies are satisfied not to hedge.
Apache Corp.'s hedges ended at the end of 2014 and haven't been
replaced, a spokeswoman said.
"Hedging is something we are constantly considering," she said,
adding that Apache feels its international operations give the
company exposure to higher global crude prices and more predictable
cash flows.
Write to Nicole Friedman at nicole.friedman@wsj.com and Erin
Ailworth at Erin.Ailworth@wsj.com
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