September 1, 2015 / 6:05 AM / 2 years ago

Europe's oil producers hedge more, eye 'lower for longer' prices

5 Min Read

LONDON, Sept 1 (Reuters) - Europe's small and medium-sized oil companies have forward-sold more crude than in previous years, ramping up their defences against a scenario in which prices stay weak for longer than expected.

Hedging future oil output against market volatility is a well-rehearsed practice among smaller producers but as prices remain historically low, they have shielded themselves more heavily than usual from a further downturn.

Second-quarter results figures showed that oil companies, including North Sea operators Ithaca and Premier Oil , have increased their hedging positions compared with the previous year.

Ithaca, a small player producing around 12,000 barrels per day, has gone as far as hedging out to mid-2017 and ramped up its 2017 forward sales by more than half over the past year.

Premier Oil had forward-sold 60 percent of its 2015 production at the half-year mark, compared with 53 percent the same time last year. A similar trend is visible among other producers.

"There are two reasons why companies have hedging programmes: one is to cover major capital projects that they have committed to and the second thing is to act as a buffer to allow them to reset the business in case of a change in oil prices," Aidan Heavey, chief executive of Tullow Oil, Africa's largest independent producer, told Reuters.

Tullow, Ithaca and Premier Oil have so far this year reaped the benefits of forward sales, with the latter selling some of its production in the first half at a hedged price of $106 a barrel, compared with an average Brent market price of around $59.

However, the recent accelerated slump in crude prices has meant companies are a little more reluctant to top up their hedging positions in fear of locking in production at the bottom of the market.

"We're not actively selling any more at this point but I would still expect us to move that (hedging) percentage up over the course of the year," Premier Oil Chief Executive Tony Durrant told Reuters.

As at June 30, Premier Oil had hedged 25 percent of its 2016 production at $69 a barrel. He said the percentage could rise to as high as 60 percent.

Many small and medium-sized oil producers sign reserves-based lending deals with banks, meaning the institution lends money to finance a specific project which is then repaid using proceeds from production.

Ithaca, which renegotiated its debt financing with lenders including Deutsche Bank, RBS and Societe Generale earlier this year, has hedged its production out to June 2017 at $69 a barrel.

Major Wall Street banks, including Goldman Sachs and Morgan Stanley, facilitate oil producers' hedging positions, giving an idea about the banks' outlook for the oil market.

Tullow Oil has hedged some of its 2016 production at an average floor price of $79.29 a barrel, falling to $76.68 in 2017 and $68.04 in 2018. EnQuest has hedged at $68 a barrel for 2016.

Winning Strategies?

If prices remain low for the next two years, those hedges would go down in history as some of the biggest winning strategies.

However, if non-OPEC production starts falling steeply, as predicted by some executives including former BP boss Tony Hayward, and prices rise on the back of a supply shortfall, the companies are set to lose a lot of money.

The recent drop in Brent prices to below $50 a barrel has created concerns among lenders about loan repayments, prompting them to encourage strong hedging positions. Premier Oil's Durrant said his company's creditors had asked for a further increase in forward sales.

"We insisted that we weren't going to do that," Durrant said.

The oil producer agreed in August to increase the level of debt repayments covered by earnings, giving the company more headroom to deal with weak oil prices. In return, it is paying higher interest rates and an up-front fee.

EnQuest and Ithaca said they themselves determined their hedging strategies, not the banks.

"The banks have been very appreciative of the way we've run the hedging programme," said EnQuest Chief Financial Officer Jonathan Swinney.

In July, credit ratings agency Standard & Poor's lowered its rating for Ithaca to negative but said the company's hedging strategy was one of the positive elements for liquidity. (Editing by Dale Hudson)

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