Why Oil Is Tumbling: Oil Hedges Were Just Rolled Over

One year ago, when oil prices first cracked and tumbled from $100 to a level some 60% lower, it took the US oil industry about 9 months to fully feel the pain and proceed with cash-saving production cuts as a result of extensive oil-price hedges that had been put on at the historical price, cushioning the blow from the price collapse driven by a drop in global oil demand coupled with a surge in Saudi oil production. The impact of these hedges was largely muted by the summer of 2015 when we first saw a notable decline in US oil production which had recently hit record levels.
And with oil volatility surging in recent months, oil producers needed to take advantage of a rally, technical or otherwise, and an oil vol lull to reestablish hedges, even if it meant at far lower prices than recent benchmarks.
This is precisely what happened in the past week following one of the most torrid surges in the price of oil seen in recent years.
So ahead of looming re-determinations, crude oil producers which piled into this decidely technical-driven rally to hedge aggressively in order to show a more stable asset base for creditors, but more importantly, to offload further price decline risks to their counterparties. Today’s reversal off $50 along with a surge in oil volatility suggests hedging activity has been aggressive, as further confirmed by Reuters..
And as a result of a new bevy of hedges put on around $50/barrell which coupled with the recent decline in the oil VIX leading to slightly cheaper hedges, firms can once again continue to produce at even lower prices as they have rebased their hedges thereby buying themselves a few more months of production at even lower prices – offsetting Saudi record production pressures. The biggest loser in this US hedging effort – the dwindling Saudi budget. The biggest winners: oil majors and other companies who rolled hedges for another 6-9-12 months, allowing crank up the production spiggot to max and generate an incremental burst in both cash flow, and production.

This post was published at Zero Hedge on 10/12/2015.