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CFTC: Shale oil boom driving decline in long-term hedging of crude oil purchases

The growth of U.S. shale oil production is the primary factor driving long-term hedgers out of the world's most liquid crude oil futures market, according to a Sept. 6 report by the U.S. Commodity Futures Trading Commission.

According to the report, overall open interest, or the number of open futures contracts, for the New York Mercantile Exchange's Light Sweet Crude Oil futures contract, remains robust. But open interest volume for contracts expiring five or more years in the future fell from a peak of 46,158 contracts in 2008, representing 46.2 million barrels of oil, to 481 contracts, or 481,000 bbl on March 29, 2018.

Oil producers told CFTC Market Intelligence Branch Division of Market Oversight staff the growth of tight oil field's share in their portfolio of assets had reduced their need to hedge physical sales of crude oil more than three years into the future, noting that they extract most oil from each tight oil well drilled within 18 to 24 months.

"As the percentage of oil-producing assets that come from tight oil fields increases, the less oil these firms have to sell three plus years from today," the report said.

Oil producers also told DMO staff that tight oil production gives them greater operational flexibility, allowing them to throttle production in response to oil prices, while conventional oil wells produce a steady flow of oil that requires the producer to sell the oil at prevailing market prices, increasing the need to hedge further along the curve.

"Firms involved in sourcing barrels of crude for clients told DMO staff that this degree of flexibility has introduced a degree of uncertainty into their ability to carry out sourcing agreements beyond three years," the report said.

Swap dealers acknowledged to the CFTC that they had fewer clients "looking for exposure in the back end of the curve," but told DMO staff that "the costs associated with holding and managing [a long-term position] have caused some clients to balk at the cost of establishing a position further down the curve."

Following recent technological advances in oil extraction, fewer market participants hold the belief that oil production has peaked, reducing the number of speculators looking to hold crude oil futures contracts in the hopes they will appreciate in value, according to the report.

"While non-financial entities who are willing to take a speculative interest in crude markets remain free to do so, changes in financial regulations have been made to severely limit, if not outright prohibit, proprietary trading by financial institutions, which accounted for some of the liquidity on the back end of the oil futures curve prior to the shale boom," the report said.