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Oil Crash Exposes New Risks for U.S. Shale Drillers

OWoN: The problem is whether the party buying the collar can pay. What a mess - Again!


U.S. shale oil production - Image: Andrew Burton / Getty


Oil Crash Exposes New Risks for U.S. Shale Drillers


Bloomberg
By Asjylyn Loder
19 December 2014

Tumbling oil prices have exposed a weakness in the insurance that some U.S. shale drillers bought to protect themselves against a crash.

At least six companies, including Pioneer Natural Resources Co. (PXD) and Noble Energy Inc. (NBL), used a strategy known as a three-way collar that doesn’t guarantee a minimum price if crude falls below a certain level, according to company filings. While three-ways can be cheaper than other hedges, they can leave drillers exposed to steep declines.

“Producers are inherently bullish,” said Mike Corley, the founder of Mercatus Energy Advisors, a Houston-based firm that advises companies on hedging strategies. “It’s just the nature of the business. You’re not going to go drill holes in the ground if you think prices are going down.”

The three-way hedges risk exacerbating a cash squeeze for companies trying to cope with the biggest plunge in oil prices this decade. West Texas Intermediate crude, the U.S. benchmark, dropped about 50 percent since June amid a worldwide glut. The Organization of Petroleum Exporting Countries decided Nov. 27 to hold production steady as the 12-member group competes for market share against U.S. shale drillers that have pushed domestic output to the highest since at least 1983.

WTI for January delivery rose $2.41, or 4.5 percent, to settle at $56.52 a barrel today on the New York Mercantile Exchange.


Debt Price

Shares of oil companies are also dropping, with a 49 percent decline in the 76-member Bloomberg Intelligence North America E&P Valuation Peers index from this year’s peak in June. The drilling had been driven by high oil prices and low-cost financing. Companies spent $1.30 for every dollar earned selling oil and gas in the third quarter, according to data compiled by Bloomberg on 56 of the U.S.-listed companies in the E&P index.

Financing costs are now rising as prices sink. The average borrowing cost for energy companies in the U.S. high-yield debt market has almost doubled to 10.43 percent from an all-time low of 5.68 percent in June, Bank of America Merrill Lynch data show.

Locking in a minimum price for crude reassures investors that companies will have the cash to keep expanding and lenders that debt can be repaid. While several companies such as Anadarko Petroleum Corp. (APC), Bonanza Creek (BCEI) Energy Inc., Callon Petroleum Co., Carrizo Oil & Gas Inc. and Parsley Energy Inc., use three-way collars, Pioneer uses more than its competitors, company records show.


'Best Hedges'

Scott Sheffield, Pioneer’s chairman and chief executive officer, said during a Nov. 5 earnings call that his company has “probably the best hedges in place among the industry.” Having pumped 89,000 barrels a day in the third quarter, Pioneer is one of the biggest oil producers in U.S. shale.

Pioneer used three-ways to cover 85 percent of its projected 2015 output, the company’s December investor presentation shows. The strategy capped the upside price at $99.36 a barrel and guaranteed a minimum, or floor, of $87.98. By themselves, those positions would ensure almost $34 a barrel more than yesterday’s price.

However, Pioneer added a third element by selling a put option, sometimes called a subfloor, at $73.54. That gives the buyer the right to sell oil at that price by a specific date.

Below that threshold, Pioneer is no longer entitled to the floor of $87.98, only the difference between the floor and the subfloor, or $14.44 on top of the market price. So at yesterday’s price of $54.11, Pioneer would realize $68.55 a barrel.


'Better Upside'

David Leaverton, a spokesman for Irving, Texas-based Pioneer, declined to comment on the company’s hedging strategy. The company said in its December investor presentation that “three-way collars protect downside while providing better upside exposure than traditional collars or swaps.”

The company hedged 95,767 barrels a day next year using the three-ways. If yesterday’s prices persist through the first quarter, Pioneer would realize $1.86 million less every day than it would have using the collar with the floor of $87.98. That would add up to more than $167 million in the first quarter, equal to about 14 percent of Pioneer’s third-quarter revenue.


Exposure Cost

The strategy ensures that the bulk of Pioneer’s production will earn more than yesterday’s market price. The three-ways will also prove valuable if oil rises above the subfloor.

“What they have is much better than nothing,” said Tim Revzan, an analyst with Sterne Agee Group Inc. in New York. “But they left some money on the table that they could have locked in at a better price.”

Noble Energy used three-ways to hedge 33,000 barrels a day, according to third-quarter SEC filings. Assuming yesterday’s prices persist, Houston-based Noble will bring in $50 million less in the first quarter than it would have by locking in the floor prices.

Bonanza Creek, based in Denver, Colorado, set up three-ways with a floor of $84.32 and a subfloor of $68.08, SEC records show. If prices stay where they are, the company will realize $8.1 million less in the first quarter than it would have by just using the floor.

Ryan Zorn, Bonanza Creek’s senior vice president of finance, said that the comparison doesn’t take into account the advantages of the strategy. The proceeds from selling the $68.08 puts helped pay for the protection at $84.32, without which Bonanza Creek would likely have purchased cheaper options with a lower floor.


'Much Better'

“The other comparison is if we’d done nothing,” Zorn said. “I view it as being much better than being unhedged.”

Representatives for Anadarko, Noble, Carrizo and Parsley didn’t return e-mails and phone calls seeking comment.

“Because we’ve had high energy prices for so long, it could have given them a false sense of confidence,” said Ray Carbone, president of Paramount Options Inc. in New York. “They picked a price they thought it wouldn’t go below. It has turned out to be very expensive.”

Callon (CPE)’s first-quarter three-ways cover 158,000 barrels with a floor of $90 and a subfloor of $75, company filings show. Callon, based in Natchez, Mississippi, will get $3.3 million less that it would have realized by using the $90 floor, assuming prices stay where they are.

“Certainly, if we’d had the foresight to know prices were going to crater, you’d want to be in the swap instead of the three-way,” said Eric Williams, a spokesman for Callon. “Swaps make more sense if you knew prices were going to go down the way they did, but a few months ago everyone was bullish.”

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2 comments :

  1. Cotrell is apparently tired of being silent

    http://www.dinarrecaps.com/our-blog/message-from-markz-and-michael-c-cottrell-posted-by-sweetqueen-at-i4u-12-20-14

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  2. The Alarming Research Behind New York's Fracking Ban
    An analysis of the findings in Governor Andrew Cuomo's 184-page review of hydraulic fracturing
    http://www.theatlantic.com/national/archive/2014/12/the-alarming-research-behind-new-yorks-fracking-ban/383868/

    The battle over untapped natural gas in New York State appears to have reached its end. Following an extensive public health review of hydraulic fracturing, Governor Andrew Cuomo announced a complete ban on the oil and natural gas harvesting practice in the state on Wednesday.

    The 184-page report, conducted by the New York State Department of Health, cites potential environmental impacts and health hazards as reasons for the ban. The research incorporates findings from multiple studies conducted across the country and highlights the following seven concerns:

    Respiratory health: The report cites the dangers of methane emissions from natural gas drilling in Texas and Pennsylvania, which have been linked to asthma and other breathing issues. Another study found that 39 percent of residents in southern Pennsylvania who lived within one kilometer of a fracking site developed upper-respiratory problems compared with 18 percent of those who lived more than two kilometers away.
    Drinking water: Shallow methane-migration underground could seep into drinking water, one study found, contaminating wells. Another found brine from deep shale formations in groundwater aquifers. The report also refers to a study of fracking communities in the Appalachian Plateau where they found methane in 82 percent of drinking water samples, and that concentrations of the chemical were six times higher in homes close to natural gas wells. Ethane was 23 times higher in homes close to fracking sites as well.
    Seismic activity: The report cites studies from Ohio and Oklahoma that explain how fracking can trigger earthquakes. Another found that fracking near Preese Hall in the United Kingdom resulted in a 2.3 magnitude earthquake as well as 1.5 magnitude earthquake.
    Climate change: Excess methane can be released into the atmosphere, which contributes to global warming. One study predicts that fracking in New York State would contribute between 7 percent and 28 percent of the volatile organic compound emissions, and between 6 percent and 18 percent of nitrogen oxide emissions in the region by 2020.
    Soil contamination: One analysis of a natural gas site found elevated levels of radioactive waste in the soil, potentially the result of surface spills.
    The community: The report refers to problems such as noise and odor pollution, citing a case in Pennsylvania where gas harvesting was linked to huge increases in automobile accidents and heavy truck crashes.
    Health complaints: Residents near active fracking sites reported having symptoms such as nausea, abdominal pain, nosebleeds, and headaches according to studies. A study in rural Colorado which examined 124,842 births between 1996 and 2009 found that those who lived closest to natural gas development sites had a 30 percent increase in congenital heart conditions. The group of births closest to development sites also had a 100-percent increased chance of developing neural tube defects.

    ReplyDelete

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