This article is brought to you by Stihl, the brand trusted by E&P managements in the United States … and around the world, to hack the &*%! out of their hedges. Ok, enough landscaping humor.
Even though I have kept particularly close attention to E&P hedging activity over the past few years. I was caught by surprise a couple of weeks ago by pre-announcements from $APA, $XOM and $FANG of projected losses from hedging (or, more accurately, from derivatives) for 2Q23. Not that the losses were that material, but they brought me a reminder that hedges are often overlooked when investors consider management performance and fundamental strategies in evaluating the merits of the various companies in the sector.
Of course, companies will provide revised hedging information when 2Q earnings are reported next week. Some may prefer significant hedges as protection on the downside from price changes, while I prefer that upside in the form of price increases be left to me to take advantage of. Frankly, I have grown tired of hearing how asset value impairments will be restored and hedging losses recovered in the future, when recent history shows that is not a universal result.
So, time for a quick dive into all recent disclosures natural gas hedging-related, following up on my recent work on oil hedges. Different timing on the disclosures, different sources (i.e. press releases, presentations, acquisition/divestiture activity, 10-Qs, etc.) makes the info less than 100%-correlated, so readers are advised to do their own diligence once actual 2Q reports are available.
It turns out, natural gas hedges were whacked further than I would have thought. In prior years, seeing the percentage of production hedged in the 50-100% range, and close to 70% overall, was not unusual. This year the % is less than half that, and likely only because many of the hedges were entered into in prior years. Hedging for ’24, for example, is minimal, where the standard % might be 50% of the ’23 volumes. The impact of volatility, sure, but what of strategy? As the saying goes in the insurance industry, “Insurance is never needed … until it is.”
As with the oil hedge charts, the majors are excluded, primarily because they have no hedges or, if they do, because they relate to non-E&P activities. Beyond those companies, $APA, $CVX, $COP, $HES, $MGY, $MTDR, $MUR, $OXY and $PXD have no significant natural gas hedges, and pristine balance sheets to back up those decisions. Several companies have made acquisitions since their last updates, so readers should look for changes in the figures to be reported shortly.
The chart below depicts the natural gas hedging disclosures for many of the remaining companies, with % hedged and hedged price depicted on the y- and x-axes, and the total production reflected by the circles. All info based on 3Q-4Q23 only.
$AR comes in with the lowest % hedged, largely due to their disastrous prior hedges and the restructuring of those with significant $ settlements. “Wide collars” is a phrase which essentially means “Yes, we are hedged, although only at prices we never expect to be reached.” Almost every company can claim to be hedged, but HOW they are hedged is more important than WHETHER they are hedged … in some fashion.
Companies with primarily natural gas production are, for the most parted, clustered in the lower right quadrant of the chart, meaning they have 20-30% of their natural gas production hedged at $3.50/mmbtu or less. $AR, $CIVI, $CRK, $CTRA, $DVN, $EOG and $MRO reside there. $CRGY and $CHK reside in the 40-60% range, and $CNX brings up the rear, as usual, with nearly 90% of its natural gas production hedged at $2.50 … for several more years.
While not reflected here, swaps and collars are roughly equal for the group, with swaps generally priced lower than collars. And upside collar ceilings are high enough so as not be to much of a factor this year. Too bad more companies didn’t use higher ‘22 prices to lock in better natural gas prices while they had the chance!
Will this year’s lack of volatility translate into even fewer natural gas hedges going forward? Time will tell, but I would not be surprised, but that would be ok with me. After all, I would prefer that companies hedge less (i.e. see $CNX) and let me make my own decisions about the direction of prices than make that decision for me.
The SMID-cap space, in particular, will reflect M&A activities that result in decision points for managements to use in deciding what to hedge going forward. FOMO and/or group-think is likely to be another big factor. And, as a final comment, companies do not hedge because banks force them to, unless you consider placing reasonable limits on debt (i.e. see $HPK) a bank decision as opposed to a management decision to live within banking regulations to achieve a certain borrowing base. Also, whether companies hedge production or hedge enough of production to cover (1) opex, (2) capex, (3) dividends (4) buybacks and (5) current or future debt repayments is actually the harder part of the hedging decision than simply hedging production at some level.
Will E&P managements continue with the chainsaw approach, or will they communicate how they plan to hedge ahead of time? Both? Neither? Buckle up; it’s almost time … again!
First time in a long time hedging seems to be good reward/risk, and then they stop doing it!
Of course, if companies were hedging more, future prices would be lower, so companies hedging at bad times is a self-fulfilling prophecy.