NEW YORK--(BUSINESS WIRE)--Link to Fitch Ratings' Report: High-Yield E&P Hedge and Netback Profiles
Update (Limited $60 Hedges Added in Q2; Full-Cycle Netbacks Suggest
Underinvestment at $50)
Hedge additions at deeply high yield (HY) U.S. exploration and production (E&P) companies were relatively limited during the $60 oil hedging opportunity in the second quarter, according to Fitch Ratings. A prolonged $50 oil price environment could lead to considerable underinvestment across Fitch's sample of 17 E&P companies with single 'B' or lower credit characteristics.
The oil price decline to$45 per barrel during third-quarter 2015 introduces the question of whether the opportunity to hedge at or above $60 per barrel during second-quarter 2015 was a missed one. Fitch reviewed the sample E&P companies to observe whether hedge positions changed and if the second quarter provided an economic entry point.
Hedge additions were observed at 11 of 17 sample E&P companies with a net aggregate increase of roughly 10%-20% to existing 2015-2017 hedge positions. Most new hedge activity was weighted toward the post-2015 period mainly due to higher average 2015 hedge position (70%) relative to 2016 (40%) and 2017 (7%) at year-end 2014. Five of the 17 sample E&P companies had no net change in their hedge positions.
Additions as a percentage of total production were offset by the 8% average increase in oil production by sample E&P companies. This effect is illustrated by the limited positive change in the average hedge positions (1%-6%) in 2015-2017, as of June 30, 2015. However, oil production across the sample may begin to decline in second-half of 2015, resulting in some improvements in overall hedge positioning.
Fitch-calculated half-cycle costs (defined as the sum of production and interest costs) have generally remained below market prices, allowing sample E&P companies to cover their cash operating costs. The average implied half-cycle oil price cost was around $35 per barrel, assuming a $3 natural gas price and fixed 42.5% natural gas liquids/oil price ratio. This suggests cash operating cost profiles were not a hedging driver.
Fitch-calculated full-cycle costs (defined as the sum of production, interest and capital costs with a 15% return on capital) have generally remained above market prices and the $60 per barrel hedge opportunity. The average implied full-cycle oil price break-even was nearly $79 per barrel assuming a $3 natural gas price and fixed 42.5% natural gas liquids/oil price ratio. This implies the $60 per barrel hedging opportunity did not support full-cycle costs and hedging decisions were a trade-off between liquidity and returns.
Current oil hedge positions, assuming a flat $50 per barrel market price, are estimated to provide five sample E&P companies with a positive hedged full-cycle netback in 2015 and only two in 2016. All sample E&P companies have negative full-cycle profiles in 2017.
For more information, see Fitch's report "High-Yield E&P Hedge and Netback Profiles Update (Limited $60 Oil Hedges Added in Q2; Full-Cycle Netbacks Suggest Underinvestment at $50)" available at www.fitchratings.com.
Additional information is available on www.fitchratings.com
The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article, which may include hyperlinks to companies and current ratings, can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.