Hedging Could Cause Problems For Some Oil Companies; EOG, CLR Are Not Hedged -- Filloon -- December 11, 2016

OPEC cut/freeze: Saudi Arabia turns to shock and awe, with bigger cuts and more countries joining, after disappointing market reaction to initial OPEC deal. -- John Kemp, via Twitter. 

Active rigs:

	12/11/2016	12/11/2015	12/11/2014	12/11/2013	12/11/2012
Active Rigs	40	65	186	192	183

Bakken update: from Filloon over at SeekingAlpha --

Summary:

• Non-OPEC cuts in oil production total between 612,000 bpd and 558,000 bpd.
• Non-OPEC cuts could take time to play out, as OPEC allowed natural declines to be used as a 2017 oil production cut
• The Saudi Oil Minister stated there could be a more sizable cut announced in the near future
• The Saudis have found the leadership role in OPEC again, and orchestrated a historic cooperative effort with non-OPEC nations

Other data points:

• Oil prices may rise from 15% to 35% over the course of the next 12 months. The initial cut by OPEC caused a 15% increase in the price of oil. This was a short squeeze. $52 proved to be a significant resistance level, as producer hedging has the benefit of contango. 

• Contango is a bearish situation that occurs when oil prices are higher in the future. Backwardation is bullish as front month prices are higher. 

• Since oil prices are now higher by $3 to $4/bbl over 12 months, operators can hedge production for better forward prices. Operators hedge to guarantee a price for production. This is encouraged by banks. Cap ex plans can be developed, as it provides revenue certainty. 

• Operators in the Permian, SCOOP/STACK, core Eagle Ford, and core Bakken see decent returns at $54/bbl or $55/bbl. Producer hedging is creating difficulties breaking to the upside. 

• Although many media outlets have reported a 558,000 bpd cut, the 12 nations reporting totaled 612,000 bpd. The OPEC/Non-OPEC cut represents 2% of world production. 

• The size and scope of cooperation is significant, and could move trading ranges higher. 

• Kazakhstan was a surprise with it's 50,000 bpd cut. It had planned to bring a new field online next year. Significant pressure must have been placed on the country, as the IEA had estimated it would increase production in 2017 by 160,000 bpd. Russian production is also a mystery. It self-reports at 11.2 million bpd. 

• Analysts have noted Russian production closer to 10.7 or 10.8 million bpd. It is possible Russia isn't cutting. OPEC has stated it would accept natural declines as cuts. It is possible these cuts may come into effect over time, and not on January 1st.

• Most of the Bakken and Eagle Ford need a steady $60/bbl oil price to increase production. Both plays will continue to see a production decrease. This will offset gains in better plays. 

• It is very important to take a look at operator's hedge books before investing. Companies like Continental and EOG Resources are not hedged and will realize the full value of a drop in world crude inventories. Many of the Permian players will report sizeable hedging losses next year if oil takes off. Many have swaps in the mid-40s.

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A Note to the Granddaughters

A beautiful, beautiful day in north Texas. A bit cool like the rest of the country but very, very pleasant. Arianna, oldest granddaughter, will be Denton all day today for water polo tournament. Four games back-to-back this morning, then afternoon break, to be followed by two early evening games. Arianna is starter on two teams, and reserve on two older-girls team and the National Program team. Pretty exciting.

After dropping her off, I drove into Denton to get cup of McDonald's coffee. Highlight of that trip: I spotted a bald-headed eagle flying above the highway in downtown Denton. Pretty cool. I've seen many eagles in North Dakota; not sure if I've seen an eagle in this part of Texas before. Will add to my bird-spotting list.

NOG Presentation Transcript

Two things I learned from this presentation:

• another operator that says they have 22 years of drilling inventory
• operators don't hedge simply to get best price; they hedge to protect liquidity

At SeekingAlpha.

Some data points:

• production: 11,000 bopd
• completing another 218 wells; 17 net wells (that's a lot of information they are privy to)
• cherry-picked 100 acres at a time since 2006; started at $35/acre in Mountrail County
• now: 182,400 acres; 121 net wells
• 1,000 remaining sites at a paltry 4 mB/3TF wells per spacing unit; doesn't include ower units;
• held by production: 70% in North Dakota
• 25,000 units held with Slawson in Richland County, MT
• recently acquired 2,000 acres at $2,500/acre; but equates to $125 million CAPEX to drill it
• at least 22 years of drilling inventory
• EOG, CLR, Slawson: 50% of their total net wells drilled to date

Definition of a "buy down":

an operator had about 75% working interest in six drilling spacing unit in one particular area. And they ask us to buy them down to 50% interest in unit because they wanted three net wells with exposure as they drilled those six units, so they could hold those units by production.

The buzz of the conference:

the new completion design by EOG where they are tripling, in some cases quadrupling, the amount of sand they are putting into these wells, which really is improving the EURs that we are seeing.

Information in real time:

We have working interest in the Continental Charlotte unit. That was their first big lower bench test where they drilled off three, all three of the lower benches of the Three Forks which was very exciting for us to participate in. We got to see that real time.

Hedging:

And again, we are basically hedged out pretty well through 2015 at about $90 a barrel, because we don’t believe that we are hedging to get the best price, we believing we are hedging to protect our liquidity position as we continue to develop this field.

Denbury, Losses, and Hedging -- Motley Fool

Link here.

DNR has joined the long list of oil companies that have reported losses this quarter on account of derivatives contracts. Based on this, it is clearly evident that companies never expected crude oil prices to shoot past $120 per barrel. And they will pay the price for that. Yet, Foolish investors should absolutely realize that there are more to these stocks than what the bottom lines are suggesting.

I think this is quite remarkable. "It is clearly evident that companies never expected crude oil prices to shoot past $120 per barrel."

Who would have thought that oil companies would show a loss because of $120 oil?

This article from 2008 is a nice primer on oil and hedging.  A "tip of the hat" to Don for finding this article.