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The spring ’20 production curtailments have precipitated a generational shift in the views on volume risk in lease crude oil purchase agreements (COPAs). A “free” volume option for producers on crude lease sales has seemingly existed for decades. But this industry assumption is now facing pushback following the deep 2Q output cuts. Many buy side aggregators were left short May volumes by sudden shut-ins, and ultimately, deeply underwater financially on those trades.

As a result, a growing number of purchasers are adding stiffer language to COPAs to balance risk in their favor. A formalized nomination process, 15 45 days before the start of the delivery month, will become more common for lease sales. This will reduce short term operational flexibility and add complexity to the forecasting/development process. Specifically, decisions on shutting in will need to be made much further in advance. The top priority for most buyers is eliminating any remaining wiggle room around economic shut-ins or “price majeure”.

There are also commercial ramifications if producer volumes fall outside an agreed operational tolerance on nominations (+/- 10% for example). The buyer now wants to be made “commercially whole” if a producer over/under nomination causes losses. Some buyers are providing detailed mechanical language on price “true-up”, while others lean towards an agreement on the meaning of “whole” and working things out.

These language changes will not spread risk evenly among producers either. Highly variable, developmental locations always benefited more from the “free” volume option than mature, heavily unitized locations. Given massive new shale well flowbacks, and frequent changes to well completion schedules (including overlapping trade months), development locations do create more volume, and in turn, market risk. 

The calculus around fixed contract deducts is also likely to evolve. Frequently referred to as “transportation” deducts these are in fact where the buyer can most readily build in margin to cover the cost of warehousing this risk and some P&L.

All of the above is open to negotiation. However, understanding your asset, and more importantly how the market views your asset from an increasingly complex frame of reference, is key commercial intelligence to hold before talks get underway. 

Producers are being forced to take a closer look at their contracts, which makes this a good time to refresh contracts and counterparties. Spare pipeline capacity sunk midstream costs is widespread. Buy side aggregators are also motivated to rebuild the business volumes that evaporated in May.

Author Profile
John Saucer
John Saucer
Vice President, Research and Analysis

Prior to joining Mobius Risk Group as Vice President of Research and Analysis, John spent 13 years at the Houston based energy fund AAA Capital Management Advisors as a Trading Principal and Petroleum Specialist. Previously, he was a Vice President of Commodity Futures Sales at Citigroup. During his 12‐year career at Citigroup, he also spent 7 years as a Vice President of Energy Analysis, responsible for fundamental research in the firm’s Futures Research Department. Prior to his work at Citigroup, John spent 5 years as a senior editor at Petroleum Argus, a leading international oil market publication. John is a graduate of The University of Texas with a BA in Economics.

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