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Insufficient Natural Gas Hedges May Impede US E&P Strategy

August 30, 2019, 08:30 AM
Filed Under: Energy
Related: Fitch Ratings

U.S. natural gas producer hedge positions should help mitigate cash flow risk and support credit profiles as Henry Hub spot prices languish but some exploration and production (E&P) companies may need to adjust capital allocation and make capital structure decisions to survive due to low prices, says Fitch Ratings. In particular, natural gas-exposed E&P companies with light hedge books and those with speculative grade or low investment-grade credit profiles may be subject to refinancing and liquidity risk due to the currently depressed natural gas price environment.

Fitch lowered its base-case assumption for Henry Hub in June to $2.75/mcf for 2019 onward due to rising gas production and improved US Gulf Coast Pipeline access lowering the marginal cost of supply. The previous assumption was $3.25/mcf for 2019 and $3.00/mcf for 2020 onward.

Narrowing Marcellus differentials in recent years, however, were supportive of realizations. The current low Henry Hub spot price environment made an effective hedge book a boon for some E&P companies with significant hedge positions. However, low investment-grade issuers, such as Antero Resources and EQT, may still be susceptible to low natural gas and natural gas liquids (NGLs) prices.

Antero Resources and CNX Resources are covering substantially all of 2020 production, assuming a second-quarter 2019 production level, with fixed-price swaps. The companies have a price advantage of $0.50/mmBtu and $0.20/mmBtu, including basis hedges, over Henry Hub strip in 2020, respectively, due to hedges. Antero Resources' solid gas hedge book supports development funding to meet midstream commitments but provides limited additional allocation optionality without triggering unfilled pipeline commitments and neglects a sizable NGLs exposure. CNX's strong hedge position, limited midstream obligations, and low cost position provide additional capital allocation optionality to optimize its pace of development and help improve its liquidity and leverage profile.

Ultra Petroleum's and Unit's low speculative-grade credit profiles reflect the heightened liquidity and refinancing risks associated with low natural gas prices and a light hedge book. Low natural gas prices forced Unit to accelerate development of oil-weighted inventory as natural gas assets are no longer economical, while a lack of hedges creates greater reliance on four-years of oil inventory to maintain its margin and leverage profile. Ultra's tight liquidity and low covenant headroom is exacerbated by the company's lack of cash flow protection.

Cabot Oil & Gas is unhedged, with respect to Henry Hub prices, as early as 2020 but the company is able to maintain financial flexibility through a low cost position as operating cash costs are below $1.00/mmcf. The company's low hedge position is a part of the operating strategy and should not affect its financial flexibility or investment-grade credit profile.

E&P companies with moderate hedge books might face less severe pricing pressure than those less hedged but still may need to make capital allocation adjustments due to low natural gas prices. Range Resources, at only 19% hedged, sold overriding royalty interests to help manage its leverage and liquidity profiles. EQT hedged 42% of 2020 production but is focused on optimizing capital, operational efficiencies and capex reductions. The company may sell noncore assets such as its Equitrans stake to reduce debt and improve liquidity. SWN is 29% hedged but must reduce development capex needs by delaying Southwestern Appalachian wet development in order to become FCF neutral. SWN's undrawn revolver and lack of near-term maturities help alleviate rating pressure.

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