A number of major US shale companies sold their crude through futures contracts at about $55/barrel, and are now missing out on the $70/barrel crude prices.  Apache photo. 

Wall Street investors disappointed in US shale revenues

A number of top US shale companies are selling their oil at significantly less than current value because last year, they sold their oil through futures contracts valued at about $55/barrel.

With lower oil prices in 2017, the deal seemed like a good one at the time.  However, the hedged bets are now cutting into revenue and frustrating investors who have been disappointed by slow returns from investments in the Permian Basin.

Denver-based PetroNerds told Reuters that the top 25 US shale producers will miss out on about $1.7 billion in combined revenues in the second quarter with oil prices at about $70/barrel because they used hedges that guaranteed them between $55 and $58/barrel.

As well, a number of Texas crude producers have been forced to cut their prices because pipeline bottlenecks in the area have boosted transportation costs.

West Texas Intermediate is now trading at a $9 discount to US benchmark futures.  The discount was $12 earlier in June.

According to Reuters, some companies protected themselves from this gap by hedging against the discount.  However, those that did not, and also hedged against future prices at $55/barrel are now forced to sell their crude in the low-to-mid $40s.

In its first-quarter regulatory filings, the biggest Permian producer, Occidental Petroleum Corp, reports it hedged using West Texas crude futures at about $59/barrel and did not hedge against the Midland differential.

The company produces about 226,000 barrels per day (b/d) in the Permian.  It does have the opportunity to offset lower drilling revenues with gains in its pipeline unit which has benefitted from the rising transportation costs.

Pipeline capacity in the area is not enough to handle the steadily increasing production numbers, according to Michael Tran, global strategist at RBC Capital Markets.

With producers pumping over 3.3 million b/d, up from 2.4 million b/d a year ago, crude storage is at capacity and pipelines are full.  Oil companies have to offer steep discounts to compensate for rising transportation costs.

The gap between the US futures price and Permian Basin crude is known as the Midland differential.  Until recently, the two have closely tracked together and firms had not hedged the discount into the price of Midland oil.

Reuters analysis of US regulatory filings discovered that by the end of the first quarter of this year, 14 shale producers hedged against 100 million barrels of 2019’s West Texas output, compared to just 40 million barrels at the end of the fourth quarter last year.

“It’s really becoming a more widely used phenomenon,” Ben Montalbano, co-founder of PetroNerds told Reuters.  He added Midland hedging volume has jumped tenfold in the last two years.

Cimarex Energy Co hedged approximately 905,000 barrels of 2019 West Texas output at a 47-cent discount to US benchmark futures.  Should US oil futures sell at $70/barrel, Cimarex will be sold at $69.53/barrel.

Companies that don’t hedge will be exposed to the Midland discount, which now sits at $9.

Reuters reports that Cimarex reported in its filings that it boosted its hedge against the differential to 3.1 million barrels.  However, about half of that was hedged at a discount of $4.83/barrel which means the company would sell its crude at $65 if futures hit $70.

Construction of new pipelines in the area is underway, but will not be online until next year.  With Permian Basin production on the rise and the pipeline bottlenecks impacting price, the Midland differential is expected to remain high.

According to a recent presentation by Occidental, the gap could reach $20/barrel by the third quarter.

“For the first time in three years, we have not had a pipeline to come on to alleviate the bottleneck,” RBC’s Tran told Reuters.

Some companies, including Apache and Pioneer Natural Resources, say they have reserved enough space on pipelines and are not concerned about the differential.

As well, Apache says it has started to hedge its Midland exposure for 2019.  Rich Dealt, CFO of Pioneer told Reuters that Pioneer does not have any such positions.

“Pioneer has firm transportation in place over the next few years to move nearly all of its Permian Basin oil production to the Gulf Coast for export or sale to refineries,” Dealt said.