Oil crash exposes new risks for US shale drillers

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Tumbling oil prices have exposed a weakness in the insurance that some US shale drillers bought to protect themselves against a crash.

At least six companies, including Pioneer Natural Resources Co and Noble Energy Inc, used a strategy known as a three-way collar that does not 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. West Texas Intermediate crude, the US benchmark, dropped 50 per cent since June amid a worldwide glut. The Organisation of  Petroleum Exporting Countries decided Nov 27 to hold production steady as the 12-member group competes for market share against US shale drillers that have pushed domestic output to the highest since at least 1983.

Shares of oil companies are also dropping, with a 49 per cent decline in the 76-member Bloomberg Intelligence North America E&P Valuation Peers index from this year’s peak in June. The drilling had been driven by high oil prices and low-cost financing. Companies spent US$1.30 for every dollar earned selling oil and gas in the third quarter, according to data compiled by Bloomberg on 56 of the US-listed companies in the E&P index.

Financing costs are now rising as prices sink. The average borrowing cost for energy companies in the US high-yield debt market has almost doubled to 10.43 per cent from an all-time low of 5.68 per cent in June, Bank of America Merrill Lynch data show.

Locking in a minimum price for crude reassures investors that companies will have the cash to keep expanding and lenders that debt can be repaid. While several companies such as Anadarko Petroleum Corp, Bonanza Creek (BCEI) Energy Inc, Callon Petroleum Co, Carrizo Oil & Gas Inc and Parsley Energy Inc, use three-way collars, Pioneer uses more than its competitors, company records show. — Bloomberg