US drillers buy protection against low oil prices, showing OPEC cuts are 'backfiring'

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U.S. drillers are insulating themselves against falling oil prices — a move that could prolong the global crude glut that the Organization of the Petroleum Exporting Countries is trying to drain.

American companies rushed to lock in higher prices for future deliveries of oil as the market recovered late last year, analysis of company disclosures by consultancy group Wood Mackenzie shows.

That threatens to keep oil flowing from U.S. fields throughout 2017, even if prices fall.

It's another sign that U.S. drillers are making it harder for OPEC and 11 other exporting nations, including Russia, to reduce huge stockpiles of crude through coordinated production cuts.

"This is looking like a complete backfiring on OPEC and what they were trying to do," said John Kilduff, founding partner at energy hedge fund Again Capital.

Oil hedge activity, source: Wood Mackenzie

Prices rebounded above $50 a barrel late last year as producing nations prepared to cut their combined output by 1.8 million barrels a day for the first half of 2017. But the higher prices not only made more U.S. production profitable, it also gave drillers the opportunity to hedge their production.

Hedging involves buying financial instruments that give producers the option to sell their oil at an agreed-upon future price. When the market falters, drillers can exercise those options to collect a higher price than markets are giving.

The practice also helps drillers fund new exploration and production without borrowing too much, which in turn helps them meet their output targets.

"The key message ... is the producers can stick to the plans they originally set out for 2017," said Andy McConn, research analyst at Wood Mackenzie.

At this point in the year, 33 of the largest American oil producers have 26 percent of their output hedged, compared with 24 percent and 23 percent of production in 2016 and 2015, respectively.

That group has hedged 648,000 barrels a day of production since the fourth quarter of 2016, a 33 percent increase from the previous quarter. Anadarko Petroleum and Apache, two of the nation's largest independent producers, accounted for 28 percent of that volume.

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That hedging is already looking like a sound investment. Oil prices have dipped back below $50 in recent weeks on concerns about rising U.S. production, particularly in the Permian Basin, and uncertainty over whether OPEC will extend its output curbs by another six months.

"One thing OPEC has to worry about is if they don't extend the production cuts, a lot of that Permian production was hedged when oil was in the mid $50s. Even if we fall back further, that production is coming on," Helima Croft, global head of commodity strategy at RBC Capital Markets, told CNBC's "Squawk on the Street" on Monday.

Hedging has its limits

McConn at Wood Mackenzie cautions against overstating the impact of hedging, though. Weaker oil prices mean drillers have fewer opportunities to hedge their production for 2018.

Wood Mackenzie believes producers need crude to recover to about $55 a barrel in order to fund planned increases in oil production next year. U.S. crude prices were trading at about $49 on Wednesday after government data showed a smaller-than-expected weekly rise in oil stockpiles.

"We think this same group of producers would be amendable to adding hedges" if the market provides the opportunity to lock in prices at $55 or $60 a barrel, McConn said.

Correction: Thirty-three of the largest American oil producers have hedged 648,000 barrels a day of production since the fourth quarter of 2016. An earlier version misstated the year.