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You would think that companies that barely survived two years ago would now be flush with earnings, but for some companies, the opposite is true, as financial contracts from a year or so ago are now coming back to bite.
Hedging allows producers to minimize price risk by locking in the price they will be paid for future production. This can smooth out revenues for a producer with a reliable stream of future production. If the price of crude rises, the producer misses out on the upside, but if it goes down the producer is insulated against losses. Futures contracts, which are highly leveraged, are traded on various exchanges and are highly liquid. If a producer enters into a futures contract and later decides it made a mistake, it can get out by selling its position in the contract.
CFOs are often not content to go this simple route. Instead, they often go for riskier bets involving options contracts. These are not really hedges; they are bets on changes in the price of oil involving leverage that makes futures contracts look very tame in comparison.
Put and call options, respectively, are the right to sell or buy crude at a fixed price at a future time. Typically, producers buy puts (to protect their production from lower prices in the future), while consumers buy calls (to protect their pocketbooks against higher prices in the future).
Futures and options contracts are highly liquid and are traded on numerous exchanges and, until recently, the most liquid were settled at the price of WTI at the trading hub located in Cushing, Oklahoma. Not all production is WTI, of course. Crude prices vary according to sulfur content, ease of transportation—because production occurs in various markets across the country and bottlenecks in transportation occur frequently—and other factors. Oil produced today in the Permian Basin faces bottlenecks in reaching markets and is expensive to transport. Permian producers receive only $53 per barrel, $17 less per barrel than the $70 per barrel posted price for WTI in Cushing.
Producers can go awry if their predictions of future wellhead prices prove inaccurate. A year ago, as the price of oil climbed above $50 per barrel, many producers thought crude prices had topped out for the foreseeable future. Backing their vision, they entered into options contracts under which, for example, they would get paid $50 per barrel regardless of the spot price at the time of delivery—they would still receive $50 per barrel if prices dropped but must pay the difference according to how much, if any, the price rose above $50 a barrel. This is called a swap contract.
Such bets have proved expensive for some producers and particularly for some of those in the Permian who did not hedge against a price divergence between the Permian and Cushing. Consider that they receive only $53 per barrel but must make up the $20 per barrel difference between the $50 swap and the WTI price of $70. They are netting $33 per barrel, less than the $40 they were getting two years ago without using any hedges, and less than the $53 they would be netting today. Earnings have been hammered further because mark-to-market accounting requires the immediate recognition of future obligations under these contracts. Pioneer Natural Resources has recognized more than $566 million in such losses for the first six months of 2018.
So, we have a classic example of good work in the field being ruined by bad bets in the office, and the damage may get worse. If the price of oil climbs high enough, some producers will find they are losing money, not just making less.
The challenge also exists for consumers. Delta Airlines (DAL) admitted to losing $4 billion on hedging through 2016 and consequently swore off the practice while oil prices were at unsustainable lows. Most recently, Delta, which also owns a refinery, reported reduced earnings as the price of fuel increased.
Playing with fire and getting burned this way is far from new. It has been going on since futures and options contracts were first introduced. Just 10 years ago, the price of crude shot to $147 per barrel and several companies would have failed had it not quickly collapsed to $32 per barrel. Anadarko faced the problem in the Denver-Julesberg Basin as a result of $65 per barrel swaps required to support its acquisition of Kerr McGee. With the price at $147 per barrel and the cost of getting oil to market at $22 per barrel, Anadarko only realized $43 per barrel.
Only time will tell how badly the financial engineers have done this time around.
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Valaris Limited announced new contracts awarded subsequent to issuing the Company’s most recent fleet status report on February 21, 2023. Three-year contract with Petrobras for drillship VALARIS DS-8. The rig will be reactivated for this contract. The total contract value is approximately $500 million, including a $30 million mobilization fee. 100-day contract with a TotalEnergies affiliate for drillship VALARIS DS-12. The contract is expected to commence in second quarter 2023. 70-day contract with Beach Energy offshore New Zealand for heavy duty modern jackup VALARIS 107. The contract is expected to commence in third quarter 2023. The total contract value is approximately $26 million. President and Chief Executive Officer Anton Dibowitz said, “We are particularly pleased to have secured the award for preservation stacked drillship VALARIS DS-8, for a contract that is expected to generate a meaningful return over the firm contract term, and we remain focused on exercising our operational leverage in a disciplined manner. This most recent award represents the sixth contract awarded to one of our high-quality stacked floaters since mid-2021, and speaks volumes about our demonstrated track record of project execution when reactivating rigs.” Dibowitz added, “Following the reactivation of VALARIS DS-17 and DS-8, we will have ten floaters working across the golden triangle, including four drillships in Brazil, a market where we expect to see continued growth over the next several years.” Updated Guidance As a result of the contract awarded to VALARIS DS-8, which will require the rig to be reactivated from preservation stack, we are updating our first quarter 2023 and full-year 2023 guidance provided on our fourth quarter 2022 conference call on February 21, 2023. First Quarter 2023 Contract drilling expense is expected to increase by approximately $5 million to $385 million to $395 million. Adjusted EBITDA is expected to decrease by approximately $5 million to negative $5 million to breakeven. Adjusted EBITDAR, which adds back one-time reactivation expense, is expected to be $25 million to $30 million, unchanged from the guidance provided on our fourth quarter 2022 conference call. Full-Year 2023 Revenues are anticipated to be $1.8 billion to $1.9 billion, unchanged from the guidance provided on our fourth quarter 2022 conference call. Contract drilling expense is expected to increase by approximately $60 million to $1.49 billion to $1.59 billion. Adjusted EBITDA is expected to decrease by approximately $60 million to $180 million to $220 million. Adjusted EBITDAR, which adds back one-time reactivation expense, is expected to be $280 million to $320 million, unchanged from the guidance provided on our fourth quarter 2022 conference call. Capital expenditures are expected to increase by $60 million to $320 million to $360 million. Source: Valaris Join our mailing list here We are #1 on Google and Bing for the "Largest Mobile Energy Network" Come join our community! Download the Rig Lynx app here
Seadrill Limited announced that the West Neptune has executed approximately six months of term extensions with LLOG Exploration Offshore, L.L.C in the US Gulf of Mexico. The extensions will commence in direct continuation of the existing term, and will keep the rig busy until Q3 2024, furthering Seadrill and LLOG’s long-term association. Total contract value for the extension is approximately $79 million. Source: Seadrill Join our mailing list here We are #1 on Google and Bing for the "Largest Mobile Energy Network" Come join our community! Download the Rig Lynx app here
Semisub rig owner Dolphin Drilling has inked a new contract with Peak Petroleum in Nigeria for its 1974-built Blackford Dolphin. The firm contract, which follows the letter of award in January, gives the Euronext Growth-listed owner of three rigs the potential to extend the unit’s backlog by a minimum of 120 days and up to 485 days. The deal adds to and will be a direct continuation of the previously announced 12-month contract with General Hydrocarbon Limited (GHL). Øystein Stray Spetalen-backed company said the effective dayrate associated with the minimum firm period of the contract is $325,000, including the mobilisation fee. “The final award of the contract for Blackford Dolphin shows the opportunities in Nigeria at a strong dayrate, in addition to building on the backlog for the rig. It also underlines the attractiveness of our assets, and we look forward to returning to revenue-generating operations in 2023,” noted Bjørnar Iversen, CEO of Dolphin Drilling. Source: Dolphin Join our mailing list here We are #1 on Google and Bing for the "Largest Mobile Energy Network" Come join our community! Download the Rig Lynx app here
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