Pioneer Hedges and Shines in Struggling U.S. Oil Patch

During the U.S. shale boom, fortune favored the bold drillers that discovered and pumped oil fastest. Today the winners are producers like Pioneer Natural Resources (PXD) who best shielded themselves from tumbling prices.

Using derivative transactions known as swaps and collars, the Texas-based firm locked in a minimum price for 85 percent of this year's production. As a result, it gets $60 per barrel for a large chunk of its output while many rivals are selling at the market price of around $30, often not even enough to cover the cost of drilling new wells.

Pioneer shares, though down 23 percent since the start of 2015, outperform a broad S&P index of oil and gas producers energy sector whose value dropped 46 percent. The company also managed to sell $1.4 billion worth of new shares to investors this month - a rare feat in a market that has shut for most energy issuers.

Its executives are not gloating over their winning hedging formula, but they are certainly sleeping better, chief operating officer Tim Dove says.

Dove told Reuters Pioneer forged its strategy, which entails hedging production two or three years in advance, after the 2008-2009 oil market crash caught it virtually unprotected. Battling for survival, the company idled 97 percent of its drilling rigs and its executives did not want to go through such "draconian cuts" ever again, he said.

"If we're going to protect ourselves, we're going to protect heavily," Dove said, describing the company's philosophy.

Now, with crude prices down by 70 percent since mid-2014, that strategy is paying off.

A Reuters analysis of late 2015 filings by the 30 largest U.S. oil firms showed Pioneer had 60 million barrels of oil hedged through 2017, nearly twice as much as any other major U.S. shale producer.

That could bring Pioneer a windfall of more than $730 million this year if oil prices stayed near current 12-year lows, according to a Reuters analysis of company data.

Tim Rezvan, energy analyst with Sterne Agee CRT, estimates that while Pioneer could get 23 percent of its revenue from oil and gas hedging this year, the majority of drillers have little or no output with price guarantees in 2016.

TIME OF RECKONING
Shale producers face a moment of reckoning after a decade-long fracking boom nearly doubled U.S. oil output and turned the United States into the world's leading natural gas producer.

With costs for new drilling in some U.S. shale areas as high as $50 a barrel, the price rout has already triggered several bankruptcies, and tightened credit for those that remain active.
For Pioneer or its smaller rival Newfield Exploration (NFX) that inspired its hedging program, locking in prices for the bulk of their future production has become a part of their annual business planning.

Newfield Chief Financial Officer Larry Massaro told Reuters hedging has been a strategic pillar for more than a decade for the Texas-based producer. It has a team that meets as often as daily to review its positions.

In global markets, Mexican state oil giant Pemex stands out as an adept hedger, having locked in a $49 price per barrel for 212 million barrels of planned oil exports this year.

But for many other oil producers to hedge or not to hedge is a daunting tactical choice.

During the long spells of $100 plus oil between 2009-2014 many drillers were reluctant to fix their prices as it meant foregoing considerable potential gains if prices moved higher.

When prices started to fall in 2014, producers faced another dilemma - buy protection against a further decline and risk losing out if there is a bounce or double down on a quick price recovery, leaving themselves fully exposed to a further slump.

That is what happened to Continental Resources (CLR). Its CEO Harold Hamm announced in November 2014 that it had cashed all of its hedges, pocketing $433 million, to "fully participate in what we anticipate will be an oil price recovery."

Analysts estimate the fateful decision has cost Continental more than $1 billion by now.

Some hedge funds and oil consumers, such as airlines, have also lost money by ending up on the wrong side of hedging bets.

In contrast, Pioneer's hedging has saved it around $1.6 billion since 2014, Dove estimated.

It has also helped Pioneer plan to lift output by as much as 20 percent annually through 2018 even as the U.S. government expects national production to fall 9 percent over the next two years.

"We're one of the few companies that is out there doing a lot of drilling," Dove said.

Pioneer, which ranks among the top 10 U.S. oil and gas producers by market value, pumps around 106,000 barrels of oil per day and is one of the largest players in the low-cost Permian basin that straddles Texas and New Mexico.

$50 HANDLE
Yet even the most comprehensive hedging program cannot offer a blanket protection against the downturn. Earlier this month, Pioneer said it planned to write down as much as $1 billion in South Texas Eagle Ford shale assets due to falling oil prices.

In racing to drill more wells, Pioneer also risks losses if crude prices stay low for longer or crater to the $20 per barrel level that some major banks have warned about.

The latest slide also makes it impossible for Pioneer and other producers to lock in attractive prices for much of their output in 2017 and beyond as options markets now offer swaps for less than $42 on 2017 U.S. benchmark crude.

Newfield is partially hedged into 2017, but it allowed positions representing 5 million barrels to expire recently and has not yet replaced them.

Pioneer locked in prices for about 20 percent of 2017 production when last June 2017 oil futures briefly rose to around $55 a barrel, Dove said, but has done few transactions since then. "We would probably want it to at least have a five handle," Dove said, referring to prices in the $50-60 a barrel range.

By Jessica Resnick-Ault and Joshua Schneyer