Latest / Energy Economics with Fexingo: Oil Prices, Renewables, and the Cost of Power / Why Oil Companies Are Hedging Like Crazy
Transcript
- Lucas: WTI crude is trading around $96 a barrel as of June first. Brent is just above $98. You'd think oil producers would be celebrating, and some of them are, but quietly, a lot of them are doing something that suggests they're not sure this rally lasts. Luna: They're hedging, aren't they? Locking in prices for future production. Lucas: Exactly. And not just a little. The latest data from the EIA shows that producers have increased their hedging positions for the second half of 2026 at a pace we haven't seen since late 2023. Open interest in crude oil put options held by producers hit a three-year high last month. Luna: So they're buying put options to guarantee a minimum price. That's classic hedging. But isn't that also kind of a bet that prices could fall? Lucas: It is. And that's the interesting tension. If you're a CEO and you truly believe oil is heading to $110 or $120, you might not hedge much — you'd want full exposure to the upside. But we're seeing ConocoPhillips, for example, publicly disclose that they've hedged about 40 percent of their expected production for the back half of this year, mostly using collars that cap the upside at around $105 but put a floor near $85. Luna: That floor near $85 is interesting because breakevens for most US shale producers are around $40 to $50 a barrel. So $85 is still very profitable. Lucas: Right, it's nowhere near a distress level. The hedging isn't about survival. It's about earnings visibility. These companies want to tell Wall Street, 'We know roughly what our cash flow will be next quarter, we can plan capital returns, dividends, buybacks.' And analysts love that certainty. Luna: But for investors who own the stock because they want pure exposure to rising oil prices, that hedge actually caps your upside. ConocoPhillips capped at $105 — if oil goes to $110 in Q3, the hedges kick in and you don't capture the full gain. Lucas: That's the trade-off. And it's why some investors prefer companies that hedge less. But what's notable right now is the sheer volume of hedging across the sector. It's not just one or two cautious CFOs. The EIA's survey of 25 large independent producers shows the average hedge ratio for 2026 output is now above 35 percent, up from about 25 percent a year ago. Luna: That's a meaningful jump. What's driving it? Is it just oil price uncertainty, or is there something specific about this year? Lucas: I think it's a combination. First, there's genuine uncertainty about demand — you've got China's exports surging, but there's a lot of chatter about a potential slowdown in global GDP growth. Second, the US election cycle always creates uncertainty around energy policy, even if the direct impact on oil production may be limited. Luna: And don't forget the OPEC factor. They've been managing supply, but there's always the risk they could step up production and flood the market. Lucas: Exactly. So producers are looking at these risks and saying, 'We can lock in $85 to $105 on half our barrels, and that gives us a very strong base case for free cash flow.' Meanwhile, the market seems to be rewarding them. XLE, the energy sector ETF, is actually up over the past five days, even as oil itself dipped. Luna: That's a little counterintuitive. Oil down, but energy stocks up. The hedging might be part of that — investors like the certainty, and they're willing to pay up for it. Lucas: Yeah, I think that's a real factor. But there's also the fact that the forward curve for crude is in backwardation — futures prices are lower than spot. That means if you don't hedge, you're effectively locking in lower prices just by waiting to sell. So hedging with puts actually lets you capture more of the spot premium. Luna: Right. The backwardation is essentially doing some of the hedging work for you. But the put premiums still cost money. Lucas: They do. But for many of these companies, the cost is manageable. The bigger question is whether the hedging surge is a contrarian signal. If everyone is hedging, maybe we're near a top in oil prices. Or maybe it just means the market is rationally preparing for a range of outcomes. Luna: That kind of thoughtful analysis is exactly why people listen to this show. And it's also why we keep it ad-free. We don't have to sell you anything, we just want to make sense of the data. Lucas: Yeah. If walking through the economy with us has made something click, and you want to support that choice, there's a link — buy me a coffee dot com slash fexingo. No pressure, but it helps us keep going without sponsors. Luna: Exactly. And now back to the hedging data — you mentioned ConocoPhillips, but are there others who hedge more aggressively? Lucas: Yes. A lot of the mid-cap producers, like Diamondback Energy and Devon Energy, tend to hedge a higher percentage of their output than the majors. Exxon, historically, has hedged very little. But even Exxon has increased its derivatives activity this year, according to their latest 10-Q. Luna: Interesting. So the trend is broad. What about the impact on the broader economy? When producers hedge, does that affect gasoline prices at all? Lucas: Indirectly, maybe a little. When producers lock in prices, they're essentially selling forward contracts. That adds supply to the futures market, which can put downward pressure on forward prices. But the impact on retail gasoline is pretty diluted. More directly, hedging gives refiners more certainty about their input costs, which can help them plan. Luna: Speaking of which, we should do a follow-up on how refiners hedge. They're in a different position — they want to lock in the crack spread, not just crude price. Lucas: Absolutely. That's a whole other episode. For today, the big takeaway is: producer hedging is surging, it's not about survival, it's about earnings visibility and managing uncertainty. And for investors, it's worth reading the hedging footnote in the quarterly report — it tells you a lot about what management really thinks. Luna: Good advice. And with that, we'll leave listeners to ponder whether the hedging wave is a sign of caution or just smart risk management. Lucas: Thanks for listening. We'll be back with more on energy economics.