By Alex Kimani| OilPrice.com | Hedging is a popular trading strategy frequently used by oil and gas producers, airlines and other heavy consumers of energy commodities to protect themselves against market fluctuations. During falling crude prices, oil producers typically use a short hedge to lock in oil prices if they believe prices are likely to go even lower in the future. With oil and gas prices hitting multi-year highs after Russia invaded Ukraine, producers that typically lock up prices preferred to hedge only lightly, or not at all, to avoid leaving money on the table if crude continued to soar. But oil and gas prices have retreated significantly since peaking mid-2022, leaving producers with minimal hedging exposed to highly volatile energy markets.
A survey by Standard Chartered of 40 independent companies (not including the major oil companies) has revealed they have little protection, with a 2025 oil hedge ratio of just 21% for their combined 5.03 million barrels per day (mb/d) of output and a 2026 hedge ratio of 4%. The volume-weighted average 2025 WTI swap is at $71.75 per barrel (bbl), while the average two-way collar has a floor of $64.20/bbl and a ceiling of $78.94/bbl. In contrast, the industry entered 2020 with an oil hedge ratio of 51.7%, which provided significant support when prices collapsed during the pandemic.
StanChart, however, says natural gas output is more protected, with hedge ratios of 40% for 2025 and 21% for 2026.
Two-way collars make up 28% of the oil hedge book, three-way collars 6% and plain put options 16%. According to commodity experts, the optionality contained in these hedges can lead to significant gamma effects, i.e., when falling prices cause banks to sell to cover their exposure to producer puts. For instance, when the 2025 WTI strip reached its YTD low on 10 March, about 250,000 barrels per day of 2025 options were in the money; however, the past week’s price rise has reduced that volume to just 34 kb/d.
Thankfully for U.S. producers, prices have so far been unable to stick below $70/bbl Brent despite significant gamma effects and heavy speculative shorting. Many traders consider the market as oversold and geopolitical risk as underpriced, with StanChart predicting further support coming from a widening view that an under-hedged U.S. shale industry will not be able to maintain output at lower prices.
Oil Prices Holding Up
StanChart notes that oil prices have held up surprisingly well over the past week despite the presence of numerous headwinds that could have pushed Brent prices more decisively below $70/bbl. Indeed, front-month Brent has exceeded $70/bbl at some point on each of the past eight trading days. Speculative positioning, however, remains skewed to the short side of the market, particularly for gasoline and crude oil, with StanChart’s money-manager positioning indices for the two commodities falling to -100.0 and -38.1, respectively. Trader sentiment remains negative largely due to concerns over the potential demand effects of U.S. tariff policies and the potential supply effects of a U.S. switch to policies that are more accommodative of Russian targets.
StanChart says several catalysts have prevented a more severe oil price crash. First, the market appears oversold in technical terms, with the move lower that has happened over the past two months lacking steam and driven purely by its own momentum. Second, geopolitical risk appears significantly underpriced. Whereas energy traders might disagree on the scale of upside price risk, few believe the market is pricing the right-side tail of the distribution correctly. Third, some of the negative sentiment at the recent London IE Week is dispersing, with traders concluding that the bearishness that dominated the week was overdone. Fourth, many traders are paying closer attention to fundamental balances, and noting the stronger-than-expected outcomes in Q4 and Q1 as well as the continuing downward pressure on inventories. Finally, traders are coming to terms with the reality of a U.S. Shale Patch that will struggle to ramp up output.
Trump says he’ll push shale producers to ramp up output, even if it means operators “drill themselves out of business.” However, commodity and energy analysts at Standard Chartered have predicted that the dramatic slowdown in U.S. oil production growth that we witnessed in 2024 will continue over the next two years. According to the experts, last year saw a sharp slowdown in non-OPEC+ supply growth from 2.46 mb/d in 2023 to 0.79 mb/d in 2024, primarily caused by a reduction in U.S. total liquids growth from 1.605 mb/d in 2023 to 734 kb/d in 2024. StanChart expects this trend to continue, with U.S. liquids growth expected to clock in at just 367 kb/d in 2025 before slowing down further to 151 kb/d in 2026.
