North American E&Ps hedging drops off in 2016, exposing group to reality of low price environment

As crude oil and natural gas prices continued to crash throughout 2015, hedging shielded many companies in the IHS North American E&P peer group from the full brunt, generating $16.7 billion in additional income for the group. However, as hedging rolls off in 2016 and 2017, revenues from hedging are set to tumble by 30% and 78%, respectively, leaving most of the group exposed to the realities of the low price environment.

The IHS North American E&P peer group has currently hedged 22% of total estimated production in 2016 and just 8% in 2017, down from 27% in fourth-quarter 2015. The group has hedged 19% of oil production and 28% of gas production in 2016, and just 5% of forecast oil and 12% of gas in 2017.

With sustained, depressed oil and gas prices, the opportunity to lock in attractively priced hedging has been lacking. Despite this, many companies have added hedging at lower prices to protect from further downside, likely at the request of their banks, lowering the weighted-average prices and intensifying the financial impact. Weighted-average hedging prices in 2016 are lower by approximately $14.00/bbl of oil and $0.70/Mcf of gas in 2016 compared with fourth-quarter 2015.

Financial strength more important than ever as hedging rolls off

We have used the debt-to-total capitalization ratio as of 31 December 2015 as a measure of each company's financial leverage. The IHS North American E&P peer group has a median debt ratio of 41%, up from 33% at 31 December 2014, as companies took on additional debt to fund capital spending budgets, which greatly exceeded cash flow throughout the year.

All the companies currently in the yellow "hedge-protected" bubble have strong hedging in 2016 but are predominantly unhedged in 2017, meaning that these companies will drop down to the red "at-risk" bubble. Many companies in the "at-risk" bubble are already financially stressed, hiring strategic and financial advisors, restructuring debt, and seeking relief from debt covenants.

Small US E&Ps: Best hedged but high debt

The Small US E&P peer group remains the best hedged in 2016 and 2017 but is also the most financially stressed. The group has a median debt-to-total capitalization ratio of 68%, and several companies have a ratio in excess of 100%. The group has currently hedged 56% of total production in 2016 and 27% in 2017.

The best hedged Small US E&Ps for oil in 2016 are Sanchez Energy, Laredo Petroleum, Halcón Resources, and Bill Barrett. For gas, Rice Energy, Sanchez Energy, Laredo Petroleum, and PDC Energy are well hedged in 2016.

Midsized US E&Ps: Exposed beyond 2016

The median company in the Midsized US E&P peer group has a debt-to-total capitalization ratio of 44%, which is significantly lower than the Small US E&Ps but still above a comfortable level. The group currently has hedged 41% of total 2016 production and 15% of total 2017 production.

Permian-focused Pioneer and WPX are the best-hedged Midsize US E&Ps for both oil and gas in 2016. Concho Resources has the best oil hedging in 2016, while SM Energy has strong gas hedging.

Large North American E&Ps: Stronger financials but little hedging

The Large US E&Ps, with a median debt-to-total capitalization ratio of 38%, are in a stronger financial position, on average, than their smaller counterparts. However, they remain the least hedged group and most exposed to market prices. The group currently has hedged only 13% of total 2016 production and just 4% of total 2017 production. Appalachian-producer Antero Resources is the best hedged, with almost 100% of its gas production hedged in both 2016 and 2017.
Canadian E&Ps: Conservative balance sheets, less hedged

The Canadian E&P group has a median debt-to-total capitalization ratio of 34%, the lowest of the four peer groups. The group's current hedging covers 27% of total production in 2016 and 11% in 2017. Peyto Exploration & Development is the best-hedged Canadian E&P in both 2016 and 2017.

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Paul O'Donnell is a Principal Analyst, Transaction and Valuation Research, for the Upstream Group at IHS Energy.
Posted on June 8, 2016

This article was published by S&P Global Commodity Insights and not by S&P Global Ratings, which is a separately managed division of S&P Global.