NEW YORK: US oil producers are rushing to take advantage of the rebound in oil markets by locking in prices for next year and beyond, safeguarding future supplies and possibly paving the way for a rebound in production.

The flurry of hedging activity in the past month will help sustain producers’ revenues even if oil markets tumble again, which is bad news for Opec nations, such as Saudi Arabia, that are counting on low prices to stunt the rapid rise of US shale and other competitors.

Oil drillers are racing to buy protection for 2016 and 2017 in the form of three-way collars and other options, according to four market sources familiar with the money flows. In some cases, that means guaranteeing a price of no less than $45 a barrel while capping potential revenues at $70.

US crude futures traded just below $60 a barrel on Thursday.

Implied volatility — a gauge of options prices — tumbled nearly 30 per cent this month to a four-month low reflecting increased options selling.

“A lot of producers that have hedges on for 2015 are under-hedged for 2016,” said John Saucer, vice president of research and analytics at Mobius Risk Group. The crude’s rally from six-year lows plumbed in January and easing option premiums have opened a “great opportunity” to buy extra insurance against a new slump, he said.

Analysts tracking hedging say that US shale producers are protected as much as 50pc less in 2015 compared with 2014. With new hedges now, producers have found an opportunity to maximise cash flow by selling calls and protecting the downside.

RISING PRICES: US West Texas Intermediate prices rose about 25pc in April, their biggest one-month gain in six years, as rising demand and deep cuts to US drilling eased fears of a supply glut.

With rising prices, producers are locking in the upside, concerned that the rally may fizzle out with US oil stockpiles at record highs — and as some producers, such as Pioneer Natural Resources start thinking about drilling again.

Pioneer is considering hedging out to 2017, chief executive Scott Sheffield told Reuters. The company says it may add more rigs in the Permian Basin this summer and has already hedged 90pc of this year’s production and 60pc for 2016.

“You can do pretty decent three-ways, but you don’t want to give up a bunch of upside,” Sheffield said last week.

A three-way collar involves buying a put option, which sets a floor for prices and selling a call option at a higher strike price, which caps gains in case of a rally but yields income that serves to offset the cost of the put options. In addition, the company sells another out-of-the-money put as well, which lowers the overall cost of the transaction but exposes the producer to greater risk if prices drop too low.

Because the transaction involves selling more options than buying, it tends to drive implied volatility lower. Hedging by oil consumers, such as airlines, which tends to drive volatility higher, has been remarkably quiet lately, dealers say.

The CBOE crude oil volatility index fell to around 37 points this week, down from a four-year high of 64 in February.

Companies may offer more details on recent hedging when they release first quarter results in coming days, though some have moved early.

Hess Corp and Cenovus Energy Inc both said this week that they boosted their derivatives books in January and February when prices were still low and options premiums high.

Oil producers and consumers have amassed the largest net short position in US oil options and futures since 2011 over the past weeks, Commodity Futures Trading Commission data show, supporting the idea that they have been sceptical about a sustained price rally.

While there are signs that four years of rapidly rising US oil output may end next month and indications that consumption is picking up, some bearish factors cloud the picture, including Saudi Arabia pumping at record levels and a record US inventory overhang.

Against that backdrop, producers are offloading options contracts, such as the WTI December 2016 $60 call. Open interest in the contract has risen by 22pc over the past five weeks while open interest for Brent December 2016 $75 call rose more than eight-fold in the last week.

Meanwhile, brokers say at-the-money WTI options straddle volumes have been low and premiums are falling, indicating expectations prices will hold mostly steady. A straddle involves buying both a call and a put at the same strike price and expiration date and traders use it to bet on changes in market volatility regardless of price direction.

Producer hedging may not by itself lead to a quick rebound in US drilling after months of cuts, warns Michael Cohen, head of energy commodities research at Barclays.

“This took five months to get here (cut production) and it’ll take five months to get out,” he said.

Published in Dawn May 2nd, 2015

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