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Natural Gas E&P Sell-Off: Hedging Gone Awry

Aug. 02, 2021 5:24 AM ETAR, CTRA, EQT, RRC75 Comments


  • Natural gas E&Ps were hit hard last week, booking large hedging losses during a period of strength for the commodity.
  • The degree of hedging between Q1 and Q2 caught many flat-footed, with short-term traders exiting positions.
  • Longer term though, the story has not changed a lot for these firms. Cash flow visibility is healthy and looks quite attractive versus valuations.
  • This idea was discussed in more depth with members of my private investing community, Energy Income Authority. Learn More »

Oil extractor
chengwaidefeng/iStock via Getty Images

Sentiment suddenly turned sour on natural gas E&Ps this week. With natural gas spot prices bumping through the $4.00 per mmbtu level recently and improvement existing throughout the forward futures curve, there has been a flood of (in my opinion) "tourist" capital

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This article was written by

Michael Boyd profile picture

Michael Boyd is an energy specialist with a decade of experience in both the investment advisory and investment banking spaces, with stints in portfolio management, residential mortgage-backed securities, derivatives, and internal audit at various firms. Today, he is a full-time investor and "independent analyst for hire.”

Michael leads the Investing Group Energy Investing Authority. The service focuses on finding total return opportunities within the energy sector, ranging from upstream producers to pipelines to refineries. Features include: model portfolios, real time trade alerts, high quality research, and an active and vibrant chatroom of professional investors. Learn More.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.

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Comments (75)

Josh Young profile picture
This context makes Sandridge all the more appealing as an unhedged gas producer seekingalpha.com/...
elwalle profile picture
The rating agencies are also involved.......weak balance sheet + unhedged positions = credit downgrades
What alot of views forget on these hedges, is they were put on when rig count was 75% below 2019 levels, also 2 big pipelines have been started from the permian basin to Mexico and Katy Tx for export as LNG. Check out Waha hub prices to HH prices, on EIA.gov, there was times it was 3-4 $ difference, it ain't no more, less than 20 cents now. There is another 2.1 bcuf/day pipeline, Whistler, coming on line in 3rd qrt. This all means no more cheap associated gas from permian basin being dumped on the US market at any price. So why would you hedge then and now with nat gas wells and oil wells still 50% below 2019 levels. Summertime is refill season, but gas going up. Lookout for winter prices, can only go up. Somebody is smoking a big fat cigar at JPM,GS,ect on the other side of these hedges! Look at eia.gov for all info on nat gas, pipelines.
Just want to Thank All the participants in this discussion for an excellent comments section!
jakeelwood5 profile picture
Hedging generally provides for at least break even during downturns and volitility of commodity prices.
Guessing wrong is one of the side effects of trying to keep afloat.
Bous Investments profile picture
CNX is hedged out to 2024. World of hurt. I believe that Range Resources has a short hedge book. Correct me if I'm wrong.
houtex profile picture
@Bous Investments
CNX is longer than that, though in smaller volumes. 184 bcf in 2025, 135 bcf in 2026, 17 bcf in 2027
soostefan profile picture
@houtex But even with those hedges they will generate fcf yields of 20%+ at current share price. This will allow them to deleverage and buy more shares if the share price will stay in the $11-15 range. Lower number of shares and lower debt will make the fcf yield even better. Long term those hedges could become a very positive element giving that you have predictability of high fcf yield.
houtex profile picture
It’s tough to say that below market hedges are a “very positive element” but no need to get into that here. I wasn’t passive judgment on CNX (I have no view), just passing along information to supplement the posts above that didn’t make clear that the hedges run beyond 2024.
the question is....when do the natgas producers stop or reduce their hedging activitie? 2022? 2023?
Even with the hedge loss, the future is bright at Antero (AR). Huge FCF yield, and exposure to liquids pricing, will have their debt under 1.5x, and as such, is grossly undervalued. I am Long AR, for a long time. And I do agree with you sentiment on Oil, and I am long MRO and MTDR (huge upside torque to oil price increases), as well as DVN. Thanks for the article.
Listening to EQT call not much discussion on earnings and costs 🤔
Without reading through the sec filings is their a brief summary of the hedging strategies of the major players and how they are different. If they are all similar my questions is moot.
houtex profile picture
They are definitely not all the same (HES buys puts, for instance). There are places like Bloomberg and some consultants who have what you’re looking for, but I don’t know if it’s available in the wild.
soostefan profile picture
@houtex Those PUTs are usually very expensive giving the high volatility. Difficult to say which is the best hedging strategy...too many variables.
houtex profile picture
All derivatives are expensive. “Costless” collars are a misnomer because you are very much paying for the downside protection, you just aren’t using cash to do so. I’m not saying puts are a better strategy (I was simply helping @GuyRien1 with his question about how strategies differ and mentioning the one clear example that came to mind), to be clear.
LOL, O&G names continuing to sell off today. Just shows they cannot make money in ANY environment. There is also no such thing as value when it come to O&G stocks, they are all just giant yield traps.
soostefan profile picture
@Randol33 Most of producers (AR, EQT, RRC, CNX etc.) are trading now at FCF yields to market cap above 15% and around 8-12% to EV, so they are actually making much more money than most of the companies from S&P 500 (average FCF yield to EV for S&P 500 is below 2%). For example AR is generating a Fcf of $750m in 2021 and higher in 2022, representing a Fcf yield to market cap of 17.6% and a Fcf yield to EV above 11%.

You are confusing making money/free cash flow with GAAP earnings that could be misleading.
houtex profile picture
“representing "what could have been" earnings if the companies had stayed unhedged into the summer surge. ”
To be clear, these don’t represent earnings that would have happened in the quarter, they are earnings that they will give up **over the entirety of their hedge book if the forward curve remains where it is**, all pulled forward to today. So “what could have been” isn’t really accurate; it’s probably better to say “what will not be.” I think most people understand this but it isn’t like AR would have had $757 million more in the bank June 30 had they not hedged at all.
Michael Boyd profile picture
@houtex I agree in hindsight, better wording from you here. Don't want any confusion.
houtex profile picture
@Michael Boyd
No problem! All this exists in a weird netherworld between “this isn’t anything you should pay attention to” and “the EPS losses are real!” Any and all exploration of the top is much appreciated. Have a great day.
Gilariverman profile picture
A few additional points on COG/XEC -

1) Both COG and XEC have large fixed gas transportation costs relative to many other gas producers due to pipeline-constrained producing locations in eastern Marcellus and Delaware Basin. Therefore, COG/XEC's net gas prices increase at a much larger rate than spot gas prices (as long as the spot gas price increases).

2) Almost all of their other respective operating expenses are relatively fixed. Therefore, almost all of any gas price increases go straight to COG/XEC's bottom line.

3) XEC's oil production is very gassy.

4) Both COG & XEC have relatively low volatility, making their call options relatively cheap (compared to other independent producers) if you think their respective stock prices are likely to go up.
Gilariverman profile picture
COG is still trading near its 52- week low, while almost all other oil and gas stocks are well above their 52-week low. In its recent earnings call, COG's marketing VP Jeff Hutton said COG is unhedged for 2022. This is extremely material, because COG's net gas price for Q2 2021 was only $2.05 after $87 million of hedging losses. COG also said it expects to grow production by 10% by the end of 2021. Yahoo Finance shows a 2021 average analyst earnings estimate of $1.63 (15 analysts) for 2021 and $1.69 (13 analysts) for 2022. An increase of $.06/share in EPS for 2022 makes no sense at all if COG's production increases by 10% and it's net gas price increase in by 50%+! It seems to me like the odds are greatly in favor of large increases in the analysts' COG earnings estimates for 2022. Of course, this is all irrespective of the upcoming combination with XEC.
ESP equity research profile picture
@Gilariverman ;
COG was way overvalued - and now it is fairly valued. It still is trading at almost 3 times NAV - when AR is still trading below NAV.

The whole "hedge" thingy is really not that important to the intrinsic value of any of these stocks. The DCF of all future cash flows = the value. This means we need to model in the next 10+ years - not just the next 3-4 quarters...
@Gilariverman just a correction: production will increase quarter-on-quarter by 4% in Q3, plus ANOTHER 10% in Q4; so by end of 2021, production increases by close to 15%. Keep in mind that realized price will be helped by the Leidy expansion, which accounts for that 10% increased production in Q4. They have a $4 hedge for that Q4 increased production, as well.
Gilariverman profile picture
@Nathan5 thank you for the good clarifications/modifications.....
andrew19067 profile picture
MB: clearly you've never run a hedging program (I have, Alu, on the LME). They producers didn't lose money, they missed potential profit. Yes, lots of it; they hedged at prices they thought at the time were going to be close to market highs- their mistake was in not taking the hedges out, rethinking the newer market dynamics, and re-hedging at far higher prices.
@andrew19067 They lost money on the hedge, which was cancelled out by the price they received. That hedge loss was lost profit they could have earned otherwise. I call that a loss.
Gilariverman profile picture
The statement, “Antero……remains fully unhedged out into 2022” could be misinterpreted by some readers. As of June 30, I see about 110 bcf of COG hedges in the $2.50 - $3.00 range for H2 2021 (note 5 page 8 of financials). In July 2021, COG placed an additional 18 bcf of hedges at ~$4.00 for the October - December 2021 period (note 5 page 8 of financials). Furthermore, COG recorded derivative losses of $87 million in Q2 2021 (see note 5 on page 9 in financial statements). It is 2022, where COG apparently is essentially unhedged.
@Gilariverman COG hedges for the rest of 2021 are substantially higher than H1, so you're not going to see another loss of $87 million. I don't think anyone has a problem with the $4 hedge for Q4, which was planned to cover the 10% Q4 increase of production as the Leidy expansion comes on line. They are going to gush FCF and return it to holders. Like KCI says below, the key is to look forward, not back.
Michael Boyd profile picture
@Gilariverman Fair point. You're right for clarification, it is the 2022 year where they have full exposure, they do have hedges this year.
Gilariverman profile picture
@Nathan5 110 bcf hedged in the $2.50 to $3.00 range for Q3 and Q4 is not a good thing when HH hub prices are slightly above $4 right now for that time period. Granted, despite these hedging losses for 2H, COG's 2H gas pricing netbacks should be quite a bit above 1H gas pricing. I am not dissing COG, I am just saying the real big unhedged pricing benefit will not be seen until 2022.
Always enjoy your analysis!
KCI Research Ltd. profile picture
Percentage returns since January 1st, 2020:

AR - Up 377.2%
RRC - Up 214.0%
EQT - Up 69.7%
SPY - Up 39.7%
COG - Down 4.9%
EOG - Down 7.7%

Percentage returns since broader equity market bottom on March 23rd, 2020

AR - Up 1334.5%
RRC - Up 339.3%
EQT - Up 146.9%
EOG - Up 121.0%
SPY - Up 95.4%
COG - Up 10.3%

Percentage returns YTD in 2021:

AR - Up 149.5%
RRC - Up 127.3%
EOG - Up 50.5%
EQT - Up 44.7%
SPY - Up 18.1%
COG - Down 0.6%

Clearly, hedging is not the main return driver here, this year-to-date, in 2021, or since the start of 2020. Additionally, part of the reason that the Appalachia producers hedged, is they grew production spectacularly from 2010-2020 in aggregate, and part of this production growth had to be financed by debt, since dry natural gas prices were in a brutal bear market and free cash flows could not finance this production growth with the strip in contango, versus its state of backwardation now. Thus, hedging in the past was smart, due to the developmental path, and the smartest of these operators are adjusting accordingly, playing to the strength of their assets, and the market is rewarding this pivot at this stage of the cycle. The key back in 2020, at the lows in March of 2020, at the start of this year, and even now, is to look forward, not backwards, which is very hard to do in practice.

I will say the playing field is more level today, as mentioned, yet like a hand of poker, you have to understand the cards you hold, and the odds at a particular juncture. The irony is that firms like AR had the best hand (in the game of energy poker) across much of the past two years, yet many could not see it, so that was the perfect betting situation, as others were convinced they had won, so they bet into that scenario, upping the size of the overall pot, and the rewards to be had for those that knew they had the winning hand (though this belief was tested strongly at times).

Best of luck to all,

@KCI Research Ltd. the guy holding the “nuts” are the firms with no or minimal edges. CLR, Mgy, SD

I want to participate on upside, All of it
KCI Research Ltd. profile picture

Who has the stone cold "nuts" (the best hand in poker anthem) is key from here, however, this is not as clear today, IMO, as it was a year or a year-and-a-half ago. Will be interesting to see how this develops going forward.

@KCI Research Ltd. fair enough and great call with AR.

The hedges are equivalent to buying AR at 4.50 and selling a 5 call. You didn’t do that due to your conviction. I wish some of these firms would have the same level of conviction. I bought Antero not because of their hedge ng position I bought it due to their unhedged NGL’s
Great timely report!! I am a still new at this but some of the surprise and difficulty with this is because company hedge information is so hard to find for the average retail investor. Always buried in the books or quarterly reports and never a function of % oil or gas produced but volumes which have to cross referenced. It seems they keep this information “close to the chest” for some reason. My question is why don’t companies spend more for collars instead of swaps and keep upside potential? Is there a financial reason or just lazy management.
Michael Boyd profile picture
@Jcraig304 I'd agree you see collars more from oil producers than natural gas, although there are some nat gas producers using collars. I think it's probably as you said: costs more to put on. Might just be habits as well.
ckarabin profile picture
I believe Antero made the comment in their quarterly that the company is in the least hedged position ever for the firm. Still hedged just not as much as previously.
Gilariverman profile picture
@ckarabin that is not saying a whole lot, because Antero has always been very heavily hedged…..
KCI Research Ltd. profile picture

For a reason. That is changing.

ESP equity research profile picture
@ckarabin ;
Yes they made that statement. AR is about 50% hedged in 2022 at $2.5. Sounds like they are not in any rush to fill in the other 50% for 2022 - but if the 2022 strips continue higher - they may lock in those huge cash flows...

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