Energy companies that locked in oil prices when crude was soaring are reaping the benefits amid oil's deep slide.
World and North American oil prices have tumbled to two-year lows on weaker-than-expected economic data from key markets and bulging global supplies, but some companies may escape the rout with cash flows largely intact because they had previously taken steps to lock in future sales at higher prices – a practice known as hedging.
Companies that hedged production earlier this year are now enjoying a cushion from oil's big drop. Calgary-based Encana Corp. said it hedged about 30,400 barrels a day of expected oil production between July and December of this year at an average West Texas intermediate price of $97.34 (U.S.) a barrel.
Oil sands producer Cenovus Energy Inc. said it added financial hedges on 14,500 barrels a day of expected 2015 production at an average Brent price of $113.64 (Canadian).
Such hedges are well above current prices for oil. U.S. crude for November delivery on Thursday settled at $82.70 (U.S.) in New York, up 92 cents, after earlier touching $79.78. Brent crude, the international benchmark, for November rose 69 cents to finish at $84.47.
"All of this stuff would be in the money now because of the swing in oil prices," said Mason Granger, fund manager at Sentry Investments in Toronto.
Other Canadian energy producers are also protected by moves to hedge production. NuVista Energy Corp., Crescent Point Energy Corp., Whitecap Resources Inc. and Bonavista Energy Corp. are the most-hedged names for 2015 among companies tracked by AltaCorp Capital in Calgary, analyst Jeremy McCrea said. For example, Bonavista has 40 per cent of its expected production hedged for next year, Mr. McCrea said.
Oil companies typically hedge a portion of their future production to add some certainty to their future revenue streams and help sustain cash flow during periods of low prices.
Companies usually have the option whether to lock in prices depending on their outlook for oil. But now, with crude prices having dropped dramatically, companies with a lot of debt on their balance sheet must hedge to ensure enough cash flow is coming in.
"The exception is names that are overleveraged, and ultimately banks will be running sensitivity analysis on a lot of these players" if crude prices continue to fall, Mr. McCrea said. "Names who are overleveraged are going to be forced to put on more hedges under this commodity-price environment."
In any event, hedging carries risk: Losses can pile up if companies are locked in to lower prices as energy prices rise.
"You can either look really bad, or really good," said Sentry's Mr. Granger.
Crescent Point actively hedges production as much as three-and-a-half years into the future to bolster quarterly payouts and capital spending, it told investors in an October presentation. However, hedging hasn't always worked in the company's favour. Crescent Point said its derivative losses – which include hedges – for oil for the three months ended June 30 deepened to $70.6-million (Canadian), compared to a loss of $8.6-million a year earlier. It attributed the losses to an increase in oil prices and hedged volumes.
For the oil industry, "the question is now that there's been a big smash in oil prices, are producers rushing out to get hedged on next year? The answer would be no," Mr. Granger said.
That could change if crude prices rally as the 2015 budget season gets under way in coming months, he said. "If we have a bit of a rebound in oil prices here, it'll probably encourage a bunch of hedging," he said.
"It's like waiting for a bounce in the stock to sell some. I think that's kind of the mentality there."