E Bakken Update: Eagle Ford Hedges May Provide Downward Oil Price Pressures

There are significant discrepancies among oil analysts as to the price of oil and its direction.Many investors are stuck in “no man’s land” after a run that has almost seen the price of WTI double since its low in February.This has created some fairly impressive gains in the US Oil ETF (USO).

(Source: Yahoo Finance)

Contango has dampened some of the gains in the USO when compared to the price of WTI, but it has still seen a healthy move. We are currently well over the 200-day moving average. If we use this as our guide, it is possible to see a considerable pull back. If the price retraces, we could see $40/bbl oil for at least a short time. We are currently following the bulls, as this run will continue until it doesn’t. Be prepared, as a pullback could translate to a 20% move to the downside.

There are a host of reasons to be bearish, but we mainly focus on world inventories. It could take a while before we see more normal levels, but supply disruptions have been positive. Nigeria and Canada have seen production decrease significantly. Goldman (GS) believes we moved to a supply deficit in May. This isn’t surprising, given the decreases in the US, OPEC and Brazil. The main questions surround the transient nature of disruptions, and a refinery maintenance season the could cause inventories to increase substantially.It looks like Nigerian production could take a while to bring back on line, but Canada is already beginning to recover from its wildfires.Demand for refined product has been much better than expectations, and we continue to believe current estimates are still below reality.It is important to watch crack spreads.Refiners are already talking about a tightening.This could continue, as refineries have been very active in this low oil price environment.

The current ceiling could be tough to break, as commodities love whole numbers.$50/bbl could be significant for other reasons, as it is a level that incentivizes operators to lock in revenues.Don’t get me wrong, many operators cannot make it at these levels.Since many operators do not have decent volumes hedged this year and in many cases close to nothing in 2017, low cost producers will have to scramble for protection.Operators know the markets will be volatile.So operators will purchase swaps, collars and three-way collars in providing short term security.Since there is a possibility of a pullback later this year, we could find operators looking to hedge around $50/bbl. This depends on geology, as breakeven can differ significantly from one section to the next. It wouldn’t be unheard of, as some operators began hedging around $40/bbl.

Geology may be one of the most important factors influencing whether an E&P will survive the downturn.Some operators do a much better job with respect to well design, but for the most part there isn’t a large difference in results if geology were to remain constant.This is why valuations are fairly close when looking at operators with similar acreage. Acreage in the Permian Basin seems to offer the quickest payback times.With lower breakeven prices, many operators began hedging at $40 to $50/bbl. We expect that hedging for core players in differing basins will occur at varying levels. While the Permian and SCOOP operators began to hedge first, as prices go up we will start to see Eagle Ford and Bakken players enter as well. This could mean we see a more staggered entry with emphasis on $50 but additional names getting in at $55 and $60/bbl. 

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