North American E&Ps Hedging More Production to Support Free Cash Flow and Returns Goals, IHS Markit Says

Investor push for greater capital discipline and stronger returns
driving strategy shifts in sector

HOUSTON–(BUSINESS WIRE)–Nodding to increased investor pressure to deliver cash flow neutrality
and stronger corporate returns, North American exploration and
production (E&P) companies were more hedged than usual as they entered
2018, says new research from IHS Markit (Nasdaq: INFO), a world leader
in critical information, analytics and solutions.

According to the IHS Markit Comparative Peer Group Analysis of North
American E&Ps, the group of 43 companies studied had hedged 25
percent of 2018 oil production, or 1.37 million barrels per day, at
$53.40 per barrel at the end of the third quarter 2017. The group had
also hedged 36 percent of gas production, or 12.37 billion cubic feet
per day, at $3.13 per million cubic feet (Mcf). This is an increase from
12 percent of oil and 31 percent of gas production hedged for 2018 at
the end of the second quarter 2017, as companies took advantage of the
initial oil-price rally to the low-$50s per barrel range.

“The North American E&P peer group is more hedged for 2018 than for
comparable periods at this time in previous years, which suggests a
shift in strategy,” said Paul O’Donnell, CFA, principal energy analyst
at IHS Markit and author of the hedging analysis. “Companies are seeking
more predictable cash flows because of greater investor demands to
improve corporate returns and keep capital spending within cash flow.”

“The higher level of hedging is less about supporting aggressive
production growth and more about increasing investor confidence that
these companies are serious about becoming more financially
disciplined,” O’Donnell said.

The IHS Markit report said the small and midsize U.S. E&P subgroups had
hedged 49 percent of total 2018 production at the end of the
third-quarter 2017, compared with 18 percent for the large North
American E&P subgroup.

“The current oil price rally to the mid-$60s per barrel range is an
opportunity for companies to build up larger hedging positions at prices
that can generate positive returns,” O’Donnell said. “We expect North
American E&P companies will report significant increases to hedge books
during the upcoming fourth quarter 2017 earnings cycle, particularly the
non-Permian focused and Large E&Ps who have previously been less-hedged.”

“More wells are economic at $50 per barrel and with oil prices now
reaching into the mid-$60 per barrel range it makes sense that companies
are using a greater amount of hedging than in prior years when oil
prices were lower,” O’Donnell said. “Companies are opting to lock-in a
larger portion of production and cash flows, which helps with capital
budgeting for the upcoming period. Again, the focus now for E&Ps is on
capital discipline and keeping capital expenditures within cash flows to
satisfy the growing investor focus on returns, rather than chasing
volume growth.”

The Permian E&P subgroup had hedged 63 percent of 2018 oil production at
the end of third-quarter 2017, a sharp increase from 36 percent at the
end of second-quarter 2017, but are likely to record hedging losses
given the average strike price of $53.14 per barrel, IHS Markit said.
The group’s average oil strike-price is below WTI oil prices, which
averaged more than $55 per barrel in the fourth quarter 2017, and are
currently around $64 per barrel.

The Appalachian E&P subgroup has hedged 49 percent of 2018 gas
production at $3.33 per Mcf at the end of the third quarter 2017. This
is a healthy premium to current futures prices, which are below $3 per
Mcf. This compares with 44 percent of 2018 gas production, which was
hedged at $3.36 per Mcf at the end of the second quarter 2017.

At the end of the third quarter 2017, the E&P peer group had also hedged
34 percent of fourth-quarter 2017 oil production at $52.97 per barrel,
and 49 percent of fourth-quarter 2017 natural gas production at $3.21
per Mcf. Given that fourth-quarter 2017 WTI prices averaged more than
$55 per barrel, IHS Markit analysts expect companies will report
realized hedging losses for the quarter.

To speak with Paul O’Donnell, please contact [email protected].
For more information about the IHS Markit Comparative Peer Group
Analysis of North American E&Ps, please contact [email protected].

About IHS Markit (www.ihsmarkit.com)

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