By Nicole Friedman And Erin Ailworth
Rocked by months of plunging crude prices, oil producers are harvesting financial bets to raise, for some, much-needed cash.
Using specialized trades with nomenclature like "three-way collars" and "butterfly spreads," producers have long used futures, options and other financial contracts to help lock in minimum prices for oil.
But after the drop in oil from more than $100 a barrel to about $50 in a matter of months, some of these hedges have shifted from a form of insurance to a source of income.
While hedges are typically held until they expire, some companies are starting to close them out early, enabling them to reap gains, sometimes hundreds of millions of dollars, bankers and traders said. Others are adjusting hedges to better protect themselves against possible further price drops.
Carrizo Oil & Gas Inc. had placed several hedges on roughly 12,100 barrels a day that guaranteed it at least $91 a barrel, on average. The company has already locked in a gain of $166.4 million from those hedges, more than its total revenue of $163.3 million last quarter, which it will collect as the hedges expire this year and next. Carrizo also added new contracts guaranteeing a minimum price of $50 a barrel for some of its oil this year and next, protection in case oil prices, as some analysts predict, fall further.
"We did this because we wanted to lock in the value we have in that asset," said Jeffrey Hayden, vice president of investor relations at Carrizo. The company didn't immediately need the cash, he said.
Craig Breslau, managing director at French bank Société Générale SA, said companies noticeably picked up activity this year. "We're seeing a lot more restructuring or termination of hedges in the early part of this year than we did in the fourth quarter of last year," he said.
On Thursday, oil for May delivery gained 4.5%, to settle at $51.43 a barrel, on the New York Mercantile Exchange. The price of crude has plunged 52% since a high hit in June, as the shale-oil boom in the U.S. has led to increased production and a surfeit of supply.
Taking the money now and putting new contracts in place "could very well be a smart move," said Thomas Heath, president of trading and financial firm ARM Financial, which helps about 90 oil producers hedge. "As long as you keep the hedge, you're not gambling."
Some producers are restructuring hedges at the behest of their lenders, which want companies to pay down debt or move hedges from the next six months to later in the future, said Paul Smith, chief executive of energy-advisory firm Mobius Risk Group in Houston.
Oil companies are still making money from the oil and natural gas they sell, but many need additional cash to make debt payments from rapid expansion over the past several years and cover operating costs amid the decline in crude prices.
Cashing out of hedges provides a one-time windfall but could leave producers in a tight spot if oil prices remain in a prolonged slump as many market watchers expect. Companies are also potentially leaving money on the table if they take profit on contracts but then oil prices fall further.
And the move can be unpopular with shareholders, who may be wary of oil companies that are forgoing protection against another leg down in prices in exchange for money now. And companies are notoriously bad at choosing when to put on and take off hedges.
"If a company has put on hedges...we would like to see that remain in place, rather than using that to take a bet on oil prices," said Matt Sallee, a portfolio manager at Tortoise Capital Advisors LLC in Leawood, Kan., who said he prefers exposure to well-hedged companies for this $17.5 billion fund.
Though many U.S. oil companies, especially smaller producers, routinely use hedges to lock in prices, many were less hedged than usual heading into the oil-price plunge that started in June. Companies were reluctant to hedge last year because a quirk in the futures market made oil prices in 2015 and 2016 much lower than 2014 prices. Producers reasoned that near-term prices would hold at about $100 a barrel, as they had for three years, meaning that the low prices offered in the market in future years weren't worth it.
Producers typically hedge about half their output for a calendar year by the end of the prior year. On average, producers have hedged 31% of their 2015 production at an average price of $83.80 a barrel and 11% of their 2016 production at $79.63 a barrel, according to investment bank Simmons & Co. International, which tracks about 40 producers.
Oklahoma City-based Continental Resources Inc. saw its share price hammered shortly after it dropped nearly all its oil hedges when crude was still priced at about $80 a barrel in early November. The oil company earned $433 million from the move, which was unanimously approved by its board, and it used the cash to cover operating costs and keep its investment-grade credit rating, Chief Executive Harold Hamm said in an interview in late February. Continental reported $1.3 billion in revenue in the last quarter.
Continental had previously locked in prices as far out as 2016, and the company left tens of millions of dollars on the table by cashing out when it did. But "that wasn't when we needed the money," Mr. Hamm said. "We need it now." Continental's stock has dropped about 23% since Nov. 3.
Cashing in hedges is part of the survival strategy being used by Energy XXI Ltd., which booked a $377 million loss in its fiscal second quarter ended in December after taking on nearly $1 billion in debt to buy a rival last summer. The Houston-based company got $73.1 million in January and February for cashing in some of this year's hedges. The company also put on new hedges at lower prices and increased the percentage of production hedged.
"We basically did it to give us some protection on the downside and still have some room on the uptick if oil happens to run," said a spokesman.
During an earnings call last month, Energy XXI Chief Executive John Schiller Jr. said the company has been focused on cost savings and low-risk projects. The company didn't respond to requests for comment.
Similarly, Austin, Texas, producer Parsley Energy Inc. said it brought in $63 million in the past few months by cashing in a portion of its hedges. The company also put on new hedges at lower prices. Parsley Energy declined to comment.
Some oil companies are satisfied not to hedge.
Apache Corp.'s hedges ended at the end of 2014 and haven't been replaced, a spokeswoman said.
"Hedging is something we are constantly considering," she said, adding that Apache feels its international operations give the company exposure to higher global crude prices and more predictable cash flows.
Write to Nicole Friedman at email@example.com and Erin Ailworth at Erin.Ailworth@wsj.com
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