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When Shale Hedges Fail: The Downside Of Three-Ways
"[Shale Oil]Producers are inherently bullish," warns one energy-hedging firm, and that truth belies the weakness in the apparent hedging programs many over-optimistic energy firms are facing now. We hear day after day that, in the short-term, low prices can be handled "because they're hedged," but producers were so exuberant about the direction of oil prices they didn't do simple linear hedges (swaps or futures) to manage price movements, but instead, as Bloomberg reports, used the so-called "three-way collar." Simply put instead of a floor and a ceiling for prices, there is a 3rd (bullish) leg of low-strike sold puts that subsidized the cost of the hedge... unless the price of oil goes below that strike, in which case the hedge fails and, as a lot of producers are finding, they are now losing money.
Tumbling oil prices have exposed a weakness in the insurance that some U.S. shale drillers bought to protect themselves against a crash.
At least six companies, including Pioneer Natural Resources Co. (PXD) and Noble Energy Inc. (NBL), used a strategy known as a three-way collar that doesn’t guarantee a minimum price if crude falls below a certain level, according to company filings. While three-ways can be cheaper than other hedges, they can leave drillers exposed to steep declines.
“Producers are inherently bullish,” said Mike Corley, the founder of Mercatus Energy Advisors, a Houston-based firm that advises companies on hedging strategies. “It’s just the nature of the business. You’re not going to go drill holes in the ground if you think prices are going down.”
The three-way hedges risk exacerbating a cash squeeze for companies trying to cope with the biggest plunge in oil prices this decade.
This is what the three-way looks like in practice...
Pioneer used three-ways to cover 85 percent of its projected 2015 output, the company’s December investor presentation shows. The strategy capped the upside price at $99.36 a barrel and guaranteed a minimum, or floor, of $87.98. By themselves, those positions would ensure almost $34 a barrel more than yesterday’s price.
However, Pioneer added a third element by selling a put option, sometimes called a subfloor, at $73.54. That gives the buyer the right to sell oil at that price by a specific date.
Below that threshold, Pioneer is no longer entitled to the floor of $87.98, only the difference between the floor and the subfloor, or $14.44 on top of the market price.
David Leaverton, a spokesman for Irving, Texas-based Pioneer, declined to comment on the company’s hedging strategy. The company said in its December investor presentation that “three-way collars protect downside while providing better upside exposure than traditional collars or swaps.”
The company hedged 95,767 barrels a day next year using the three-ways. If yesterday’s prices persist through the first quarter, Pioneer would realize $1.86 million less every day than it would have using the collar with the floor of $87.98. That would add up to more than $167 million in the first quarter, equal to about 14 percent of Pioneer’s third-quarter revenue.
And then there's this brilliant insight...
“Certainly, if we’d had the foresight to know prices were going to crater, you’d want to be in the swap instead of the three-way,” said Eric Williams, a spokesman for Callon. “Swaps make more sense if you knew prices were going to go down the way they did, but a few months ago everyone was bullish.”
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So... not hedged then!?
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Im fucked. Instead of paying my student loans this month, I bought puts and Janet does this to me. If Kevin Henry really is buying spy contracts, someone should fucking jump the prick.
These guys should have used plain vanilla put spreads.
What you don't understand about options trading will bite you in the ass,
every time.
Shades of Bob Citron and Orange County.
There never is a lack of patsies.
To echo some earlier musings as to collateral damage, unexpected consequences and the like, a nice piece from the Telegraph
http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/113004...
There is just so much wrong right now.
Be still and listen
Good piece in the Telegraph. Seems to repeat at least once each generation.
When will we ever learn?
Sure does repeat, doesn't it. While I was reading it, the litany of all the "same all over agains" were playing through my mind. Oil, currency, borrow short lend long, derivatives, leverage, etc., and it's just one or a combination repeated with infinite hubris, time after time.
Nothing changes but the players and how it's packaged.
Nothing.
Why, even reading some financial history from way back in Issac Newton's days, there were active markets in futures and options for gold, wine, silver, etc., speculation run rampant, leverage and even bullion banks extending loans collateral many times over, paper commodities, etc.
Never stops.
And won't. It's the Human Condition. Nothing more deep or complex than that. The Human Condition
As P.T. Barnum stated: "there's a sucker born every minute". Though nowadays it seems like their born every second.
… they’re puttin’
fertility pills in the water !
How does FOMC statement + Quaditching + DodFrank repeal = you buying PUTS?
Hindsight has me painfully asking myself exactly that question.
Geopolitics sucks, no matter how you hedge.
Time to bend over, and take it.
Martha Stewart shows us how bending over and taking it isn't so bad.
That gets an upvote but I must say, she looks a lot like Yellen....
Sounds like they herped when they should have derped.
"We herped some folks."
Can shale oil producers call a "self-help", like the stock exchanges?
I dont know about producers, but if any roughnecks or drillers with girlfriends named Candy are out there and have just gotten the layoff news, I can offer help. I will put her up in the "Bunkhouse" and promise to feed her well, Im sure me and Candy can come to some sort of terms.
But, I do have a plywood cutout that all applicants must fit thru to qualify. Kinda like you must be this high to ride this ride at Disney. Afterall, to much Candy can be a bad thing.
Interested parties, reply to: ridethewhitepony.net
The Government: A Hundred Ways to Fuck You
A hundred????!!!!
You are, surely, an optimist.
tyler, you're behind with the latest israel - gaza news.
The Hedge, this seems to break the simplest law of physics. I have heard a million times that this or that investment is hedged. So it is no lose. Look, physics agree there is no lose, but only if the losses show up somewher else in the system.
If things are hedged, that means a counter party takes the loss and makes you whole. We found out how good that worked in AIG 2008. You are only as good as your counter party. If there is a loss, like there will be in Fracking Stocks and Profits, then some counter party is there to take your losses and make you whole. He is the hedge everyone goes on about. He losses when the hedge is called in.
I suspect most hedges are all bullshit smoke and mirrors designed to suck investors in to the desired products. In this case, buying bonds of Frackers, or if you are a bank, straight out loans to frackers. Of course everyone will hedge that investment. But tell me, since ALL are Hedged, how are counter parties going to make EVERYBODY WHOLE. Short answer: "The are not" Default! Somebody is going to default and fail to pay up. The Losses must, according to physical law, show up on someone's books.
2008 showed how much hedges were worth. In many cases, "not much".
Everyone talks like there will be no losses, no economic costs, because all things are hedged. This is a joke, consult any physics book and the simple laws that begin them. The sytsem will reflect the loss, someone will pay, no matter if you have a hedge counter party on Mars to make good your Fracking Bond defaults.
As long as the loser is the taxpayer, it's no problem......
Unless you pay taxes.
Well, no- the third leg of this strategy is the sold put, which is actually unhedged, and thus has loss risk down to $0 oil-
It's a case of the dumbasses being greedy and trying finance their hedge, hoping their hedge itself would be enough protection-
whoops, got caught.
Funny you bring that up Jack. Anyone remember that investment company that had more Noble prizes than any other and the John Meriwheter and his former Salmon Brothers bond brain trust?
What was the catalyst that blew up their shitty supposedly hedged portfolio? Where their data never used any long tails? What was the catalyst? Russia.
Almost brought down the global financial system.
"But tell me, since ALL are Hedged, how are counter parties going to make EVERYBODY WHOLE?"
Obama signed the bill this week to make the taxpayer the stuffie so all ARE hedged except the taxpayer which is the way it should be in a bought system
Shale me up new green coal coke nigga pleaz, cuz the the Niger in the WH is planning a nez waz to loop da peasants to barginz invensentzmenz.
edit. sorry, forgot my sarc tag
Well first off Bloomtards, I know for a fact that Nobel Drilling is not a shale driller unless they have moved onshore in a big way lately. They mostly operate Big platforms in the Gulf of Mexico offshore. If memory serves, I think Pioneer is the same, deep water gulf type operator. Shows how much research they do before writing their drivel.
As for Nobel Drilling, it could not happen to a bigger bunch of blithering incompetent butt kissing idiots, 20/25 years ago they told me I had a job with them and I drove to 500 mi Morgan City, LA
I interviewed, took welding tests, sent to a private practice doctor for a physical, attended two days of safety training, some kind of sea training , Got sent to take a complete Body cat scan. 5 freaking days of crap and then I got finished and they said , oh just kidding we decided not to hire anyone. Me and 60 other guys from all over the country just stood their with our mouths open.
I asked them what? You dumb-asses just spend 20,000 dollars a head x 60 to talk to some new people or what. The MRI alone was like 5 grand. I guess just throw away money and waste peoples time? I left that building after cussing every last one of them from the president down calling them about every thing I could think of and they were certainly ready for me to leave. I hope they BURN. Figures, collars LOL
These ain't like yur Daddys markets were Dipshits, the tail is wagging the Dog. There is so much leveraged hot money out there its taking down entire soveriegn nations, much less your miserable little drilling cos. Nothing is safe or immune.
"Aaaaand...thats the Gamble!..................Lets look at what they could have won"
Annnnnnnd! Over here in box number 1 was the entire.... are you ready? CITY OF LONDON!
Yes, each and every last one of you producers bet the bank, all in, options none ..... get the joke boys, options none ..... that you were gonna become the biggest swinging dicks in the oil patch and instead, the sheriff is coming to evict your poor asses from your homes.
Better luck next time "folks"
Who?
Oh, them.
Oh, they're some folks with the Federal Bankruptcy court here examining your properties.
Those guys with them?
Oh, they're from ExxonMobil. They're showing some real interest in the land.
Oh them?
Yeah, well, they're with the Department of Energy making sure that your claims as to value are not over stated.
Oh no, they're not in collusion. We're from the government and here to help you.
Why, didn't you get the memo?
Remember, Barack told you that you weren't good guys, that renewables were the way to go. Well, folks, this is just one step along the path to his vision.
Poor kid form Kenya hit it big.
That's America for ya!
Ummmm, they forgot to add that below the 73.54 level is a MARGINABLE POSITION!! Can you say blowouts if we go much lower!!
So they hedged 95,000+ barrels per day for 2015??
Thats 95 contracts a day OR 34,675 total contracts OR $34.6 MILLION in margin money they have to put up every 1.00 BELOW 73.54!
How many different ways can you say --FUCKED?!
Saker has some pretty cool data showing that Russia is not really being hurt in sanctions and the ruble on their oil and gas revenues.
http://www.vineyardsaker.blogspot.com/2014/12/crouching-sanctions-hidden...
Either reggae’s sperm sample in Obama’s ass or Michelle’s salivating DNA for food can benchmark the US universal currency backed by something. Janet Yellen is drafting up new MBS conditions to resell triple AAA bonded investments under a Presidential Memoranda piece of paper.
Again, forgot /sarc
Three-ways have several downsides. Unless the girls are sincerely into each other, you are going to spend too much time warming them up and choreographing it gets distracting; not to mention changing prophylactics and so forth.
U R my hero
Predatory traders are bullying the market down to create distress in Shale to then buy distressed companies. It's the new Big Short. There's little doubt in my mind GS is exploiting this (being the most evil institution this side of the Atlantic).
this is a tragedy for 40+ bankrupt companys in 4 years time after borrowing from the banks to keep the cash flow going
I wouldn't worry about RRC. They are in a lot better shape than some. 20-25% growth on 18% less capex for 2015. And while they left some money on the table with their hedges, they still are hedged. I can't imagine any of their 26 lenders capitulating.
'Everyone has a plan, until they get punched in the mouth!" -MTyson