OREANDA-NEWS. The recent improvement in crude prices has bolstered the earnings outlook for US independent producers, but a new challenge may be looming as existing hedges roll off.

Particularly under pressure are medium- to small-sized oil and gas producers whose hedges have in part helped them secure funding from lenders to boost liquidity as cash flows get squeezed because of lower oil prices.

Companies like Devon and Oasis Petroleum have solid hedges for this year but a volatile market that saw prices plunge from mid-2014 highs to near six-year lows early this year kept them away from locking-in hedges for coming years.

Devon, one of the first independents to revise upward its 2015 output guidance following a fall in drilling costs, attributed $600mn in first quarter revenue to its oil and natural gas hedges. As of 31 March, its hedges for the rest of the year had a fair-market value of $1.6bn, but the company doesn't have any hedges for 2016.

"We would like, over any given point of time, to have about 50pc of our oil and our natural gas financially hedged," executive vice president for marketing Darryl Smette said in May. "But in the current price environment, we look at the natural gas and the oil price strip for 2016, it's not something that excites us."

That has prompted US bank Oppenheimer to downgrade Devon to Perform from Outperform. "Despite higher benchmark strip prices, continued production growth, cost savings and efficiency improvements, we expect 2016 earnings to be significantly below the 2015 level," it said. Devon may face cash flow deficits of $1.9bn next year versus $0.9bn this year, Oppenheimer said.

Similarly, Oasis Petroleum, which has over 60pc of its expected 2015 output hedged at over $83/bl, has protection for only 2,000 b/d, or under 5pc of its production, at $62.98/bl WTI for the first half of next year and 1,000 b/d at $65.10/bl for the second half of 2016. Hedges will help improve revenue by $300mn this year, but without any significant cover for 2016, Oasis will have to rely on previously drilled but uncompleted wells to just keep production flat next year if it sticks to its plan to stay within capex, analysts with Tudor Pickering Holt (TPH) said.

Given the unclear market outlook, Oasis plans to gradually add hedges.

"The way we look at it internally is we layer things in, on small chunks, ones and twos, and watch where the market goes. Ones and twos as in thousands of barrels a day," chief executive Tommy Nusz said.

Others, like EP Energy, are well protected for this year and next, but face risks for 2017 especially as debt repayments come due. Without a strong hedge cover, EP Energy doesn't have too many other avenues to tap for funds with $4.7bn in debt due between 2019 and 2022. The company has 96pc of expected oil output and 95pc of gas output covered for this year and 82pc of oil and 11pc of gas for next. In 2017, EP has only 18pc of oil covered and no cover for gas, which the company describes as "consistent with our practice of opportunistically legging into hedge positions over time."

Even bigger producers like EOG Resources and Hess are struggling to add new positions. EOG, which made a net cash gain of $367.7mn from hedges in the first quarter and $222.9mn in the fourth quarter of last year, is looking "to put some hedges in going into next year," chief executive Bill Thomas said.

Hess in February hedged 50,000 b/d of crude from 1 March through the end of 2015 at a floor price of $60/bl and a ceiling of $80/bl.

Some producers are able to add hedged, however. Pioneer Natural Resources has 82,000 b/d, or about 90pc, of its 2015 oil volume protected at $71/bl, among the best among larger producers. For 2016, Pioneer has changed its strategy, entering into collar contracts for 83,000 b/d at a floor of $68.38/bl and a ceiling of $78.47/bl. That kind of cover allows the company to "foresee whether we're adding rigs or not," chief operating officer Tim Dove said.

Among smaller producers, Halcon Resources is adding hedges as per its plan to cover 80pc of its expected 2016 output at a floor price of $80/bl. It had 31,410 b/d of oil hedged at $90.28/bl from 1 April to 31 December. For 2016, it had 24,497 b/d at $81.12/bl. "We don't have that much further to go to reach our goal," chief financial officer Mark Mize said.