The rally in crude oil is reviving the U.S. shale boom, threatening speculators who are the most bullish on prices since July.                                                                                 

Money managers increased their net-long position in West Texas Intermediate crude by 3.9% in the seven days ended May 5, U.S. Commodity Futures Trading Commission data show. That’s a level last seen toward the start of last year’s price crash. Short positions declined to the lowest this year.

A 37% rebound in WTI since March has encouraged companies, including EOG Resources Inc., to lay out plans to resume drilling. The shale boom had stalled amid a record decline in rigs seeking oil, and the government is predicting lower output this month. Any acceleration in drilling will raise concern that the U.S. supply glut could worsen.

“We could soon see a second surge of production growth,” said Stewart Glickman, an equity analyst at S&P Capital IQ in New York. “EOG is a rather conservative company, so if they are willing to dip their toes back in the water, others will as well.”

WTI futures gained $3.34 to $60.40/bbl on the New York Mercantile Exchange in the period covered by the CFTC report. The contract lost 16 cents to $59.23/bbl in electronic trading at 11:44 a.m. Singapore time.

EOG, the biggest U.S. shale oil producer, said May 5 that it plans to increase drilling as soon as prices stabilize at about $65.

Production Outlook

Shale-oil explorer Pioneer Natural Resources Co. said it’s preparing to deploy more rigs as early as July, while Carrizo Oil & Gas Inc., Devon Energy Corp. and Chesapeake Energy Corp. last week raised their full-year production outlooks.

Following the announcements, prices tumbled 3.3% on May 7, having reached this year’s high.

Even as the number of rigs seeking oil fell for a 22nd consecutive week as of May 8, there were some signs of improvement. Drillers returned one rig to the Permian basin, the nation’s biggest oil play, Baker Hughes Inc. data show. That followed the addition of a rig a week earlier in the Willison basin, where North Dakota’s Bakken shale formation lies.

“A lot of people piled in thinking that production is going to fall off dramatically,” said John Kilduff, a partner at Again Capital, a New York-based hedge fund that focuses on energy. “But the likelihood is that more production is going to come online, not less. Things are only going to get worse.”

Falling Production

Oil output will decline from June through September before rebounding in the final quarter of this year, the Energy Information Administration forecasts. Production will average 9.23 MMbopd this year, the highest since 1972, and rise to 9.31 million in 2016.

Crude stockpiles slipped 3.88 MMbbl in the seven days ended May 1 after expanding for 16 consecutive weeks to 490.9 million. That’s the highest level since 1930, based on monthly records. Inventories are more than 100 MMbbl above the five-year average for this time of year.

Oil prices increasing to $65 for an extended period may add an extra 500,000 bpd by the end of next year, according to Bloomberg Intelligence. The number of wells waiting to be hydraulically fractured, known as the fracklog, has increased as companies wait for costs to drop or prices to rise.

Net-long positions in WTI rose by 10,032 to 268,163 futures and options in the week ended May 5. Short bets dropped 18% to 63,881, while long positions slipped 1.3% to 332,044.

Other Markets

In other markets, net-short wagers on U.S. natural gas fell 43% to 72,225. The measure includes an index of four contracts adjusted to futures equivalents. Nymex natural gas jumped 10% to $2.78 per million British thermal units during the report week.

Bullish bets on gasoline fell 2.7% to 24,969. Futures climbed 3.1% to $2.0634 a gallon on the Nymex.

The U.S. average retail price of regular gasoline gained 0.8 cent to $2.659 a gallon on May 7, the highest level since December, according to Heathrow, Florida-based AAA, the nation’s biggest motoring group.

Bearish wagers on U.S. ultra low sulfur diesel shrank by 38% to 8,426. The fuel rose 5.1% to $2.0145 a gallon.

OPEC Output

As U.S. producers prepare to increase output, other countries keep pumping more oil. The Organization of Petroleum Exporting Countries produced 31.3 MMbopd in April, above the group’s quota of 30 million for an 11th month, according to data compiled by Bloomberg. Saudi Arabia led OPEC in a decision in November to maintain production levels. The group’s next meeting is in June.

“I don’t think OPEC is going to do any kind of cut next month,” said Tariq Zahir, a New York-based commodity fund manager at Tyche Capital Advisors.

“Production here in the U.S. will pick up. You could
see significantly lower prices.”

Noble Energy and Rosetta Resources have announced a definitive merger agreement whereby Noble Energy will acquire all of the common stock of Rosetta in an all-stock transaction valued at $2.1 billion, plus the assumption of Rosetta's net debt of $1.8 billion.

Rosetta's liquids-rich asset base includes approximately 50,000 net acres in the Eagle Ford shale and 56,000 net acres in the Permian (46,000 acres in the Delaware basin and 10,000 acres in the Midland basin). Noble Energy has identified in excess of 1,800 gross horizontal drilling locations for development, providing net unrisked resource potential of approximately 1 Bboe.

Rosetta's assets produced 66,000 boed in the first quarter of 2015, and year-end 2014 proved reserves were 282 MMboe. More than 60% of Rosetta's current production and proved reserves are liquids. Noble Energy anticipates a compounded annual production growth rate from these assets over the next several years of approximately 15%, generating positive free cash flow on an annual basis.

Dave Stover, Noble Energy's Chairman, CEO, and President, stated, "I am excited to announce this strategic transaction, which adds two exceptional and material areas to our global portfolio. The Eagle Ford and the Permian are premier unconventional resource plays, two of the most economic in the U.S., which will expand our resource base and development inventory and further diversify our portfolio.”

Under the definitive agreement, Rosetta shareholders will receive 0.542 of a share of Noble Energy common stock for each share of Rosetta common stock held. Based on the Noble Energy closing price on May 8, 2015, the transaction has an implied value to Rosetta shareholders of $26.62 per share, representing a 28% premium to the average price of Rosetta stock over the last 30 trading days. Following the transaction, shareholders of Rosetta are expected to own 9.6% of the outstanding shares of Noble Energy.

The boards of directors of both companies have unanimously approved the terms of the agreement, and Rosetta's board has recommended that its shareholders approve the transaction. Completion of the transaction is subject to the approval of the Rosetta shareholders and certain regulatory approvals and customary conditions. The transaction is expected to close in the third quarter of 2015.

The first major shale deal after the worst oil price collapse in five years is a model for future transactions that promises to quickly change the industry as companies expand in new areas or soak up struggling rivals.                                            

Noble Energy Inc.’s $2.1 billion all-stock purchase of Rosetta Resources Inc. is poised to be an opening salvo in a long-predicted wave of industry consolidation that’s been slow to materialize since crude fell by more than half since June.

As a stock-for-stock deal, Rosetta shareholders would see the benefit from a rebound in oil prices, a key sticking point after the value of North American energy companies fell by more than $200 billion since June, according to data compiled by Bloomberg.

“Both shareholders then get to participate in the upside going forward,” Noble Chairman and Chief Executive Officer Dave Stover said Monday in an interview. Such deals will give shareholders more confidence that they’ll benefit from shale mergers by creating “a stronger company overall.”

Rosetta shareholders will get 0.542 Noble share for each share they hold, giving them 9.6% of the outstanding shares of Noble, according to a statement Monday. The deal values Rosetta at $26.62 a share -- 38% more than the producer’s closing price on Friday.

The premium is below average for the past five years, according to Fadel Gheit, a New York-based analyst for Oppenheimer & Co. That’s a signal that there are more deals to come as buyers and sellers come together on price.

‘Big Deal’

“We’re going to see a lot of mergers and acquisitions,” Gheit said Monday in a telephone interview. “Everybody is looking for the big deal.”

Investors didn’t immediately welcome the acquisition, as Noble’s shares fell as much as 7.8%, the most intraday in four months, and were down 6.6% to $45.90 at 12:13 p.m. in New York. Still, the deal indicates merger activity is returning to the market, Neal Dingmann, an analyst at SunTrust Banks Inc., said in a note to investors Monday.

Other takeover targets are likely to have operations in West Texas’s Permian Basin, including Matador Resources Co., Callon Petroleum Co., Carrizo Oil & Gas Inc. and other smaller companies similar to Rosetta, he said. Concho Resources Inc. and Pioneer Natural Resources Co. are larger companies that could be attractive to a buyer with deeper pockets, Dingmann said.

Martijn Rats, an oil analyst at Morgan Stanley, said in a report on Monday that M&A was “arguably” a cheaper option for growth than organic investment. “Upstream M&A will likely accelerate as confidence grows,” he said.

Stalled Transactions

For months after the oil market collapsed, deals were stalled by disagreements on valuation as sellers insisted on a higher price than buyers were willing to pay, and the bottom of the downturn remained uncertain. Now, an oil rally has signaled a potential rebound, with prices up more than 30 percent in the past seven weeks.

Noble’s transaction follows a decline in deal value and volume among oil and gas producers during the first three months of the year, according to a Monday report by consultant PricewaterhouseCoopers LLP.

PricewaterhouseCoopers tallied 12 transactions, a 60% decline from the year-earlier quarter. Deal value dropped 72%, to $3.6 billion. The Permian was the most-active field for deals in the quarter, followed by the Eagle Ford, according to the report.

New Opportunities

“The velocity and magnitude of the decline in oil prices have caused companies to focus internally on cost reduction and productivity enhancement activities, which have taken attention away from M&A as a growth vehicle,” Doug Meier, the consulting firm’s energy sector deals leader, said in a statement.

“The current low price environment may present opportunities for potential acquirers who have the balance sheets to finance deals and the investing horizon to see through the current lows of the business cycle,” he said.

The current deal comes as major international explorers and shale giants from Exxon Mobil Corp. to EOG Resources Inc. have all signaled an interest in taking advantage of lower valuations to add to their North American shale resources.

The goal is either to expand existing land positions in the major U.S. drilling areas or to acquire access to a new area, as was the case in the Noble-Rosetta deal.

With Rosetta, Noble will add 1,800 drilling locations in two of the three biggest U.S. shale oil fields. Rosetta’s assets include 50,000 acres in the Eagle Ford and 56,000 acres in the Permian. Rosetta produced 66,000 boepd in the first quarter from the two regions, of which more than 60 percent was liquids.

“It’s really the quality of the asset, the inventory, that attracted us,” Noble CEO Stover said.

Noble will assume Rosetta’s net debt of $1.8 billion, the Houston-based companies said on Monday.

The largest takeover in the sector announced this year is the pending $53 billion purchase of BG Group Plc by Royal Dutch Shell Plc.

LINN Energy, LLC and LinnCo, LLC announced Monday that LINN has signed a definitive agreement to sell its remaining position in Howard County in the Permian basin for a contract price of $281 million.

The properties sold include approximately 6,400 net acres prospective for horizontal Wolfcamp drilling and approximately 2.0 Mboed of current production from 133 gross wells.

The transaction is subject to satisfactory completion of title and environmental due diligence, as well as the satisfaction of closing conditions.

The transaction is expected to close in third-quarter 2015 with an effective date of May 1, 2015.

The insurance protecting shale drillers against plummeting prices has become so crucial that for one company, SandRidge Energy Inc., payments from the hedges accounted for a stunning 64% of first- quarter revenue.

Now the safety net is going away.

The insurance that producers bought before the collapse in oil -- much of which guaranteed minimum prices of $90/bbl or more -- is expiring. As they do, investors are left to wonder how these companies will make up the $3.7 billion the hedges earned them in the first-quarter after crude sunk below $60 from a peak of $107 in mid-2014.

“A year ago, you could hedge at $85 to $90, and now it’s in the low $60s,” said Chris Lang, a Senior V.P. with Asset Risk Management, a hedging adviser for more than 100 exploration and production companies. “Next year it’s really going to come to a head.”

The hedges staved off an acute shortage of cash for shale companies and helped keep lenders from cutting credit lines, many of which are up for renewal in October. With drillers burdened by interest payments on $235 billion of debt, $89 billion of it high-yield, a U.S. regulator has warned banks to beware of the “emerging risk” of lending to energy companies.

Payments from hedges accounted for at least 15% of first-quarter revenue at 30 of the 62 oil and gas companies in the Bloomberg Intelligence North America Exploration and Production Index. Revenue, already down 37% in the last year, will fall further as drillers cash out contracts that paid $90/bbl even when oil fell below $44.

Increased Efficiency

West Texas Intermediate for August delivery added 4 cents to $57/bbl in electronic trading on the New York Mercantile Exchange at 11:29 a.m. Singapore time.

Hedges purchased from banks or other traders allow drillers to lock in a sale price. Some guarantee a specific value. Others ensure a minimum payment regardless of how much the market moves, but require the oil company to pay some of it back if the price exceeds a certain threshold.

SandRidge, the Oklahoma City-based producer, had about 90% of its oil and natural gas liquids output hedged in early 2015, according to a regulatory filing. Next year, the hedges cover less than a third.

SandRidge stock traded yesterday at 85 cents, down 88% in the last year. More than $3 billion of its bonds are trading at 62 cents on the dollar or less.

Jeff Wilson, a spokesman for the company, said declining well costs and increased efficiency are helping SandRidge achieve returns comparable to what the company made at higher prices. SandRidge issued $1.25 billion in bonds last month, which gives the company the liquidity it needs, Wilson said.

Buy Time

For SandRidge and other drillers, the hedges, required by some lenders, gave them enough time to cut spending. Costs in shale fields have fallen by 20 to 30% and productivity has increased as producers moved rigs to the most prolific regions. Producers were able to raise about $44 billion in equity and debt in the first-quarter, according to UBS AG.

“That postponed the day of reckoning,” said Carl Tricoli, co-founder of private-equity firm Denham Capital Management.

At Goodrich Petroleum Corp., hedges accounted for 35% of revenue in the first three months of 2015. Most of its insurance runs out at the end of the year, company records show.

Daniel Jenkins, Director of corporate planning and investor relations for Goodrich in Houston, didn’t return calls seeking comment.

Supportive Lenders

Oasis Petroleum Inc., one of the most active drillers in North Dakota’s Bakken shale, received almost $91/bbl for 19,000 bpd. That accounts for more than 40% of its daily production and is the biggest piece of its hedging program. At the end of June, the guaranteed price drops to $77, company records show. By January, the company will have just 2,000 bpd hedged at $65/bbl.

Richard Robuck, V.P. of finance for Oasis, said the company’s hedges worked perfectly. The cash infusion gave Oasis the time it needed to cut back from 16 drilling rigs to four, which will allow the company to spend less than it brings in, even at lower prices. Oasis also has a “very supportive lender group,” plenty of room on its credit line and a plan to add new hedges for next year, he said.

“There’s a chance prices fall, and there’s a chance they go up,” Robuck said. “It’s the oil business. That’s why we hedge.”

Forecasters including Citigroup Inc. and Bank of America Corp. see U.S. crude falling further in the final six months of the year. UBS predicts prices will slide as low as $50/bbl.

Regulator Scrutiny

With oil prices down 45% in the past year, the industry is facing scrutiny from lenders and their regulator. Banks typically evaluate credit lines to oil and gas companies twice a year. The next time is October, and by then many of the drillers’ hedging contracts will have run out. The U.S. Office of the Comptroller of the Currency has expressed concern that the banks it supervises be more careful about lending to energy firms.

“Some companies are not nearly as well-hedged for 2016 as they were for this year,” said Omar Samji, a partner in law firm Jones Day’s energy practice. “They’re going to have a real cash-flow crunch.”

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