Play defense. That’s a strategy producers can use to lessen exposure to commodity price volatility in 2015, according to Chris Lang, senior vice president with Asset Risk Management’s (ARM) hedge advisory service. The firm advises some 100 E&Ps, and in mid-December, as crude prices fell, Lang said conversations with clients hadn’t revealed panic. Rather, many producers were embracing the opportunities embedded in the chaos.

ARM’s business is not to forecast prices but rather to develop convictions about value. “We assess the fundamentals and analyze markets to identify opportunities to help producers make effective risk-management decisions,” Lang said.

Globally, crude markets are oversupplied. “We find comfort that we aren’t talking about a global economic recession,” Lang said. Still, with crude demand this year expected to post an increase of 1 million barrels per day (bbl/d) against a 1.5 million bbl/d surge in production, the surplus is real.

This past fall, producers reacted immediately as crude prices weakened. From October to November, drilling permits dropped 25% in the Bakken and 50% in the Permian, Lang noted. No longer slaves to HBP requirements, producers can be more disciplined in their reaction to oversupply. “Clients are circling the wagons to reevaluate. We expect producers to reduce capex to fund drilling out of cash flow. Many have balance-sheet strength and good assets, and for them, it’s a buying opportunity.”

Earlier in 2014, ARM was advising clients to layer in swaps opportunistically quarter-to-quarter to manage backwardation. Today, some with an alternative use for the cash are considering unwinding their positions to pay down debt and further strengthen the balance sheet.

Crude prices will likely recover somewhat through 2015, but the bottom may not have been reached, Lang said. Resource-oriented players with a significant production wedge can position themselves by buying puts in 2015 and financing them by selling calls in 2016 and 2017. Conventional operators can opportunistically layer in swaps to protect balance sheets in 2015 while retaining some flexibility, and exposure to upside, for 2016 and 2017. In the case of one client, “We were able to buy an at-the-money put at $68 and pay for it by selling the $90 call in 2016 and 2017 on equal volumes, for a zero net cash outlay,” Lang said.

As for natural gas, “We entered the season at a storage deficit, and then had the coldest November since 1995, so we got off to a good early start,” Lang said. Weather largely drives the price, but at press time, the forecast was for a mild early to mid-December. The longer-term forecast called for a 5% to 8% colder-than-normal winter, but when compared to last year’s 30-year-cold winter, it may not look so bullish, Lang said. By year-end 2014 the storage deficit was expected to flip to a surplus, “and then by March or so the Marcellus Shale supply growth will be the main headline driver,” he said. The eastern shale giant was expected to post a 4 Bcf/d gain in supply, depressing prices.

To play the gas market, “We’re looking at three-way producer collars in the first quarter to define a floor and leave room for upside participation, while adopting a more defensive position for the remainder of the year with enhanced swaps,” Lang said. “Be opportunistic in the first quarter but then defensive, because once we exit peak heating demand, that supply is going to be like a tidal wave.”

Natural gas could rally in 2016. ARM’s analysts tally 100 gas-intensive projects to come on line over the next several years. Also, the NET Mexico Midstream pipeline will be completed by the end of 2015, adding capacity of 2.3 Bcf into Mexico. Power demand will turn upward as coal plants are retired, and LNG export facilities could export 5 to 12 Bcf/d by 2020. The curve is overvalued in 2015 and undervalued in 2016 and beyond, Lang said, so the latter could be a transition year.

Bright spots for natural gas producers beyond the Marcellus, where lower costs preserve returns, include the Rockies, where Lang said the basis should remain firm. Rockies producers that can move their gas west will reach a captive audience.

“The current volatility accentuates how important it is to manage price risk,” Lang said. “As fast as we’ve fallen in crude, you could start to build a fundamental case for a recovery, so while seeking to protect ourselves from a fall from $68 to $60, you don’t want to miss a $25 rally—it’s imperative to adopt an active approach to maximize your downside protection and participation in higher prices over time.”

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