U.S. Shale Producers Increase Hedges, Frustrating The Already Weak OPEC Strategy

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U.S. shale producers add a large number of hedges for 2017, 2018.

This is another major indicator OPEC has lost its former power.

The move should trigger even more U.S. shale production over next two years.

One of the numerous reasons the production cut deal isn't going to work is because of hedges, which it appears a number of U.S. shale producers have quickly rushed into immediately after the announcement of the agreement.

Based upon the rapid flattening of the oil futures curve, there can be no doubt there has been a quick move by shale producers to lock in future sales prices and cash flows because of the foolish decision to cut production by OPEC.

The worst thing about that in my view is it's highly unlikely there'll be any meaningful or sustainable production cuts in the first place, which means OPEC could have added to the oil production problem, rather than alleviate it some.

Not only do I now expect U.S. shale production to climb in 2017, which I've been stating for a long time, it's going to soar to higher levels than I was originally expected as a result of locking in these type of prices, which if there hadn't been an announced deal, wouldn't have artificially jumped.

So with little in the change of the pace of the oil demand outlook, U.S. shale producers have been handed a gift from OPEC; one which will come back to haunt them over the next couple of years. Only a massive and unexpected jump in demand would counter this outcome. There is nothing in the market that suggests that's even a probability, let alone a possibility.

Source: Bloomberg Finance

Oil futures curve

With all the hoopla leading up to the announced production cut, one which was being treated by the media as if it wasn't inevitable, there was no doubt the price of oil was going to soar immediately after the confirmation some type of deal would be put in place. It was obvious the emotion associated with the announcement would be a temporary positive catalyst.

Knowing that, many U.S. shale producers were ready to quickly move to lock in these higher prices; prices which would probably have otherwise not come about anytime soon. It also points to the fact the U.S. shale producers weren't believing the higher end price projections of 2017 and 2018, otherwise they wouldn't have locked in the price of oil in the mid-$50s per barrel.

As for the proof I and others see a significant increase in hedging, it's confirmed by the shape of the curve, which rapidly flattened after the announcement of a production cut by OPEC and Russia. That without a doubt means producers are ramping up hedging to lock in prices over the next couple of years.

What to expect from U.S. shale producers

The consequence of this will be for a number of U.S. shale producers to boost production beyond the already-expected robust levels I've been looking for in 2017 and 2018. Not only has the announced production cut provided stronger motivation and prices for current and near term production, it will accelerate the production levels of American shale producers further out.

With the misguided idea put in motion, it means what the market was unlikely to do in the near future, OPEC has now artificially done with its verbal intervention: provided stable and predictable prices and cash flows that will aid shale management in making decisions based upon future expectations, which are now very clear.

This isn't an automatic guarantee of profits for shale producers. It will depend on how prepared and active each company was when anticipating the fast and upward move of the price of oil they were going to hedge. To me, this will determine the winners and losers over the next couple of years, and will also put pressure on shale leaders that didn't aggressively hedge. Those companies will struggle against their peers that were ready.

We won't know the individual responses from each company until the next earnings report, but the shale industry as a whole will be far stronger as a result of the announced production cut, than before it.

Confirms OPEC's loss of influence and power

I've been saying it for at least a year, and will continue to reinforce my thesis - which is the correct one - that OPEC no longer controls the destiny and prices of oil, U.S. shale producers do.

As I've been saying, there is nothing OPEC can do to grab back its former role as swing producer. The financial media and old school analysts and pundits have yet to learn that, but more than likely this foray into former strategies that can no longer work, should be the teaching tool that finally convinces them, or at least give them a glimpse into the light of what is obviously happening right before their eyes.

There are a lot of other factors in play here, such as whether or not some OPEC members and Russia, will adhere to the deal at all. There is also the fact U.S. shale producers have reduced the cost of production to such levels they can profitably compete with newer wells with the price of oil at about $45 per barrel. They have already been increasing supply to the market by adding rigs and completing more wells. As already mentioned, the higher price of oil and hedging it will accelerate the pace of increasing supply from U.S. shale producers. That in turn will totally frustrate the proposed OPEC cut.


I've never been impressed by or a believer in the value of an OPEC cut, and have publicly stated it time and time again. The hedging by American shale producers adds one more reason to the many for maintaining my outlook on the matter.

What now remains to be seen is how many shale producers locked in high oil prices for the next couple of years, and what it means for each one of them. That will primarily be determined by how many drilled but uncompleted wells they have in their inventory at this time, and how quickly they bring them to market.

With the production cut announcement by OPEC, it couldn't have created a better opportunity for U.S. shale producers to lock in a predictable price point and cash flow projection, which will make them ever more difficult to compete against.

Now they can make decisions based upon a much more visible future than they had just a few days ago. For that reason, not only will they be much more profitable than the market had been looking for over the next couple of years, but they will force OPEC to give up any semblance of the production cut being one based in reality.

After all, there are no mechanisms in place to punish any country that ignores the quotas they had placed on them. This makes the deal, not really a deal, but a suggestion. It also means few if any OPEC producers, or Russia, will adhere to the quotas. The media will be fed information suggesting otherwise, but it's something the market will increasingly disbelieve.

This deal was just too good to be true, and the market won't take long to figure that out. For shale producers, they've already become the winners from the cut, and they're going to punish OPEC by increasing production and supply.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.