Kemp: Rising Oil Prices Throw Lifeline to Shale Producers


    Brent prices for 2017 ended trading above $50 per barrel on Wednesday for the first time since mid-December following the largest and most sustained rally in prices since the oil slump started.

    The average for the 12 futures contracts expiring in 2017, called the calendar strip, has risen by 34 percent from its recent low of $37.45 on Jan. 20 to $50.26 on April 27 ().

    Spot prices, represented by the nearest futures contract, dominate the headlines and are of most interest to analysts and financial investors.

    Most hedge funds and other money managers concentrate on nearby futures contracts because they are the most liquid.

    Calendar strips for future quarters and years are far less prominently reported in the media and analyst commentaries.

    But the majority of crude producers and consumers such as airlines rely on calendar strips to hedge future sales and purchases.

    For producers struggling to meet debt payments and avoid breaching the terms of loan covenants, rising prices are a chance to lock in future revenue and reduce downside risks.

    Many producers, especially in the U.S. shale industry, must be hoping prices continue to rise in the second half of 2016 and through 2017 as the oil market rebalances.

    But the calendar strip has already risen to the point where it is line with the average price forecasts for 2017 made back at the start of March.

    At that point, half the respondents to a broad price survey expected prices to average between $45 and $55 per barrel in 2017.

    By remaining unhedged, producers have the chance to benefit from further price increases. But any pull back could put their very survival at risk.

    For many shale producers, the difference between an average price of $35 and $50 per barrel is the difference between insolvency and survival.

    Prudence counsels most shale producers should protect part, if not all, of their production for 2017 at current price levels against any reversal.

    In early 2015, many producers missed the opportunity to lock in higher prices when spot prices rallied between January and May to more than $65 per barrel and then suffered grievously when prices retreated to fresh lows.

    Given the fragility of market rebalancing, and the financial exhaustion of many U.S. onshore oil producers, the safer course now is to start locking in at current prices, even at the risk of giving away some upside.

    Many shale producers have already begun to lock in a large share of their 2017 projected production, according to recent earnings updates and investor presentations.

    Hedging should enable at least the stronger and better capitalised companies to protect their core operations through the uncertain period until the cycle enters a proper upswing.

    (Editing by David Evans)




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