Crude oil prices continued to surge after the Organization of the Petroleum Exporting Countries (OPEC+ group) failed to come to any conclusion regarding the ramping up of oil production.
Experts predicted that the crude prices will reach $100 before the end of the year. Even as oil prices continue to rise, US shale oil companies have not given any indication that they will be raising production levels to shore up oil prices. While production is being increased to cater to the rising demand as economies are slowly coming out of COVID-19 lockdowns, the share prices of US shale oil companies continued to follow crude prices closely.
However, while crude prices have been rising along with shares, shale oil companies have already reported losses worth $7.5 billion.
What Ails Shale?
Shale oil companies have incurred huge losses since they hedged future crude contracts at nearly $55 a barrel, a far cry from the $75 a barrel that crude is currently being sold at. This price differential is the reason behind the losses, which can add another $12 billion in the red in the second half of the year if the crude prices remain at the same level.
The increased losses allow the OPEC and the OPEC+ group more freedom in determining crude prices.
The Hedge Effect
US shale oil companies had hedged against oil prices as the companies had believed that crude oil prices would fall by this point in the year. However, with the OPEC+ talks failing, there was no industry-wide increase in production levels, further elevating crude futures. These elevated price levels meant that the companies had hedged for prices that were under the current crude prices, leading to large losses.
Consultancy firm Wood Mackenzie reported that 53 oil producers have hedged about 32 percent of expected 2021 production volumes, a smaller percentage compared to that from a year ago. The companies have combined losses of $3.2 billion in the first quarter just from bad hedges, the company said.
With such losses, shale companies are now much more reluctant to hedge against crude prices.
“With every bank saying that oil will be at $90-$100, no one is going to put hedges on right now,” said an executive at a shale oil producer to Reuters.
Shale Shocked?
While shale companies can increase their own production to bring down crude oil prices, and reduce any losses on their hedged futures, they are not doing so. Companies are instead choosing to keep their production levels flat and ride out the highs of the international crude oil market. With backwardation in the industry, prices of immediate deliveries being higher than futures, keeping production levels flat will lead to increased returns, especially for investors.
Many companies are also using this oil rally to sell off assets in order to gain capital to divest into greener industries.
Shale oil companies have been able to more or less cope with the losses, being on track to generate $30 billion of free cash this year, according to Bloomberg Intelligence.
Shale oil companies are also establishing their own benchmark to combat market fluctuations. Something that will keep futures contracts safer from wider market effects.
Source: CNBC TV18