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Oil Producers Prepare for Second-Half Slump as Rally Sputters

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Oil producers aren’t betting on the rally.

After surviving two years of low prices, they’re gearing up for a third by buying protection against a renewed downturn. Laredo Petroleum Inc. said July 14 that it hedged more than 2 million barrels of 2017 output earlier this month. Drillers have increased bets on falling prices by 29 percent this year.

Crude has declined more than 10 percent since hitting a 2016 peak in early June, stoking fears of another second-half slump. It was July that broke the back of last year’s bull-run, with oil plummeting 21 percent. The prospect of a repeat has drillers doing everything they can to raise cash, from selling stocks and bonds to adding fresh hedges.

“The producers have sold the hell out of this rally,” said Stephen Schork, president of Schork Group Inc., a consulting firm in Villanova, Pennsylvania. “The companies that did survive, they’ve been hedging into this rally. And they’re counting their blessings.”

Hedging has become a critical cash lifeline for companies that have so far survived a bust that has claimed dozens of their competitors. Since the start of 2015, 85 North American oil and gas producers have gone bankrupt, according to law firm Haynes & Boone LLP.

Producers increased bets on falling prices for a third consecutive week in the seven days ended July 12, according to data from the Commodity Futures Trading Commission. Short wagers rose by 8,566 futures and options combined, or 1.6 percent. 

Drillers are also taking advantage of the rally to tap the capital markets. U.S. oil and gas producers have been selling shares at record speed, using the cash to repay debt or buy oil and gas prospects, bolstering the asset side of the balance sheet. So far this year, companies have raised more than $16 billion in equity, according to data compiled by Bloomberg. 

“They’re trying to generate cash to stay alive and fight another day,” said John Kilduff, partner at Again Capital LLC, a New York hedge fund focused on energy. “The producers know full well that the oil market is not out of the woods yet.”

If this year is anything like the last two, producers may be grateful they shored up their finances. Oil dropped 38 percent in the second half of 2015 and 49 percent in 2014. There are already signs that a gasoline supply glut may back up into the crude markets, damping demand.

Gasoline Supplies

Gasoline inventories are so swollen that at least five sea tankers hauling the fuel to New York were turned away over the past few weeks, according to traders and ship-tracking data compiled by Bloomberg. U.S gasoline stockpiles rose 0.5 percent to 240.1 million barrels, an all-time seasonal high, in the week ended July 8, the Energy Information Administration reported last week.

The peak-driving season in the U.S. has so far failed to erode those stockpiles, which may send crude tumbling below $40 a barrel again, according to Schork. 

“Demand is strong, but supply is even stronger,” he said.

Money managers cut bullish bets on Nymex gasoline to the lowest level in almost six years, according to the CFTC report. Long positions declined by 2,652 futures and options combined, or 7.2 percent. Net positions fell to an eight-month low. Futures advanced 0.1 percent during the report week to $1.4301, and settled at $1.422 on July 15.

In oil, money managers boosted net-long bets by 10,970 futures and options combined, or 6.5 percent, to 180,469. West Texas Intermediate rose 20 cents to $46.80 a barrel during the report week and traded at $45.27 as of 8:46 a.m. New York time on Monday.

“The rising inventories of gasoline have got the markets’ attention,” Kilduff said. “The oil market is getting ready to break.”

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