OREANDA-NEWS.  Hedge additions at deeply high yield (HY) U.S. exploration and production (E&P) companies were relatively limited during the \\$60 oil hedging opportunity in the second quarter, according to Fitch Ratings. A prolonged \\$50 oil price environment could lead to considerable underinvestment across Fitch's sample of 17 E&P companies with single 'B' or lower credit characteristics.

The oil price decline to\\$45 per barrel during third-quarter 2015 introduces the question of whether the opportunity to hedge at or above \\$60 per barrel during second-quarter 2015 was a missed one. Fitch reviewed the sample E&P companies to observe whether hedge positions changed and if the second quarter provided an economic entry point.

Hedge additions were observed at 11 of 17 sample E&P companies with a net aggregate increase of roughly 10%-20% to existing 2015-2017 hedge positions. Most new hedge activity was weighted toward the post-2015 period mainly due to higher average 2015 hedge position (70%) relative to 2016 (40%) and 2017 (7%) at year-end 2014. Five of the 17 sample E&P companies had no net change in their hedge positions.

Additions as a percentage of total production were offset by the 8% average increase in oil production by sample E&P companies. This effect is illustrated by the limited positive change in the average hedge positions (1%-6%) in 2015-2017, as of June 30, 2015. However, oil production across the sample may begin to decline in second-half of 2015, resulting in some improvements in overall hedge positioning.

Fitch-calculated half-cycle costs (defined as the sum of production and interest costs) have generally remained below market prices, allowing sample E&P companies to cover their cash operating costs. The average implied half-cycle oil price cost was around \\$35 per barrel, assuming a \\$3 natural gas price and fixed 42.5% natural gas liquids/oil price ratio. This suggests cash operating cost profiles were not a hedging driver.

Fitch-calculated full-cycle costs (defined as the sum of production, interest and capital costs with a 15% return on capital) have generally remained above market prices and the \\$60 per barrel hedge opportunity. The average implied full-cycle oil price break-even was nearly \\$79 per barrel assuming a \\$3 natural gas price and fixed 42.5% natural gas liquids/oil price ratio. This implies the \\$60 per barrel hedging opportunity did not support full-cycle costs and hedging decisions were a trade-off between liquidity and returns.

Current oil hedge positions, assuming a flat \\$50 per barrel market price, are estimated to provide five sample E&P companies with a positive hedged full-cycle netback in 2015 and only two in 2016. All sample E&P companies have negative full-cycle profiles in 2017.