As oil climbed into the $50s of late, E&Ps doubled down on hedging to help fund and reinvigorate their 2018 drilling programs. A recent report from analysts at Cowen & Co. equity research, led by analyst Charles Robertson II, looked at the effect that stepped up hedging could have on the price of West Texas Intermediate (WTI) as well as ramifications for service providers if capital programs surge.

The Cowen team noted that “strong demand, sector rotation and geopolitical events” have combined to create a more positive environment for oil equities and the commodity in general. That’s come as a relief to the oil and gas industry after a protracted downturn. But as is often the case in the world of commodities, the hedging frenzy downside could be pressure on crude prices.

The good news for service providers is that if hedging jumpstarts more drilling next year as E&Ps pump up capital budgets, there may be more tolerance for cost mark-ups. “Service in the Permian is still tight but WTI moving above $55 will force E&Ps to accept inflation in our view,” the analysts said.

We may have found a floor of sorts for crude in the past couple of years, and now we may get glimmers of a ceiling. “Second-quarter results revealed that U.S. E&Ps would stop adding rigs when prices for WTI crude are in the mid-$40s. Now the market is looking for the price point where U.S. E&Ps will begin adding rigs, which we believe is the mid-$50s,” they added.

Crude equities have indeed rebounded. Cowen’s assessment of monthly stock performance for September found that Unit is up by 31%, Whiting 26%, Oasis 35%, Anadarko 22%, and Hess, Apache, Concho Energy and Devon and Noble by anywhere from 17% to 19%. “The negative sentiment trade rally is topping out,” the Cowen analysts said, even though the ramp-up could end up depressing that recent price rise.

On their third-quarter conference calls, E&Ps are expected to forecast “incremental” rig additions in the first quarter of next year, but not to begin a significant surge in drilling unless WTI prices move above $55 and hold through the third-quarter earnings period. That further price movement “would result in a greater increase in activity starting the next mini-cycle, in our view,” the analysts said.

Services remain tight, however, so a ramp-up could be muted. A recent report from Bernstein looked in depth at North American oilfield services and fracturing in particular. It found that the fracking recovery has been “spectacular with demand at least three times higher than the middle of last year.” The Bernstein analysts, led by Colin Davies, found that price increases are sticking and margins are recovering.

Is a stall around the corner as the oil price ceiling comes more into focus? The report indicates there will be slowing in demand for fracturing, but the still significant number of DUCs and the emphasis on bigger fracks may provide support. The Bernstein analysts noted, however, that hydraulic fracturing is highly sensitive to crude prices. “A multiyear $45 to $50/bbl profile would not be enough to sustain long-term growth. Demand and price would stall potentially, causing another mini-cycle of activity adjustment,” they said.

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