Saudi Arabia’s drastic action of promising production increases and reducing selling prices by $8 sent WTI oil futures down to near $30/Bbl last night. The April contract was still in the low $30s late this morning.
Market participants may be assuming some oil production shut-ins in April. AEGIS observes the natural gas market in West Texas (at the Waha hub) put on a fierce rally this morning. Prices for the summer strip (April through October) rose by $0.51 today. We see this as evidence that associated gas supply may not be as high this summer as was thought, as recently as Friday. This is consistent with less associated gas production, the result of shutting-in oil production.
Some clients have been exploring how to use this weak pricing as an opportunity to monetize hedges – by perhaps taking the mark-to-market gain as cash, repurpose the gains into new structures, or otherwise reduce hedges. Others are looking for opportunities to adjust the hedge portfolio as option valuations have changed considerably.
Hedge Adjustments: Rationale
AEGIS clients’ hedges were about 73% of their forecasted production heading into Monday’s trading. They were well covered. Those existing hedges are worth a LOT of money. Consider this: among the hedges in place, the AEGIS swaps for the remainder of 2020 were done at an average price of $60.04. Of the costless collars, the average floor price was $51.06.
That means the average swap hedge has an unrealized gain of near $27/Bbl this morning, and some clients are trying to convert it to a realized gain.
Clients should expect some resistance from trading counterparties – banks or swap-dealing merchant traders – if they want to take gains from existing hedges.
With prices this low, credit departments are likely to be assessing higher credit risk from most, if not all, producers. AEGIS has already observed less advantageous price indications in some situations.
Our take? If you want to reverse, or otherwise monetize, a hedge, keep some protection. Use some the cash earned to add put options, for example. Prices could get worse. Global supply could be 2.5 MMBbl/d higher two months from now.
Some clients are using current option values to adjust their portfolios. For example, a call option sold as part of a costless collar are now worth much less than they were when traded.
Trades done through AEGIS had a weighted average ceiling of $61.19/Bbl for 2020 tenors. WTI traded at half that value last night. Those call options can now be repurchased – and thereby removed from the portfolio – for a fraction of the original cost. Why do that? If prices rally before expiration, you would then have unlimited upside.