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A lot are hedged 100% through 2015 and 1/4 to 3/4 of 2016. And those hedges will be in the high $80's to $90's mostly. But to add to that, they have to hit their production targets for those, which is where oversupply kicks in.

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That's not how hedging works. It's a paper trade and rarely involves the actual delivery of physical barrels. Typical hedges involve swaps, puts, calls, or collars which is buying a put and selling a call together.

In a swap the producer simply agrees to sell so many contracts (1000 bbls/contract) at a certain price at a certain time. This is usually done close to the strike price for that futures contract. Let's say a produced decided in January of 2014 that they were happy to sell 3000 barrels in August at the strike price of $90/bbl. They would call their broker and tell him they want 3 August swaps at the strike price. The cost to enter this trade would be minimal since each side of the contract is taking on the same amount of risk. When the August contract expires, oil is at $85/bbl. That producer would then collect $5 per barrel from the counter-party to their swap contract or $15,000 total. If the contract expired at $95, the producer would pay the counter-party $15,000.

The same producer wants the option to sell 3,000 bbls in August for $90/bbl, but doesn't want to sell at $90 per barrel if oil is above $90 per barrel. He would call his broker say he wants to buy 3 August $90 puts. He has no risk if oil goes above $90 in August, but if it settles below $90, he gets paid the difference between the average monthly price and $90. If the August contract expires at an average of $85/bbl, the producer receives $15,000 from the counter-party. If the August contract expires at $95/bbl, the producer does nothing, his contracts expired out of the money. Buying these puts cost money because the risk is not equal on each side of the trade. The producer probably paid ~$3/bbl to buy the puts or $9,000 to enter this trade.

The same producer thinks oil may settle below the $90/bbl strike price for August, but they don't want to be locked into a swap, and they don't want to pay out money for puts. They can enter a costless collar in which they buy $80 puts for $1/bbl and sell $100 calls for $1/bbl. If oil settles below $80, they collect the different. If oil settles above $100, they pay the difference. If oil settles between $80 and $100, the contracts expire out of the money and no one pays or collects anything.

Now here's where your production targets statement is wrong; anyone can enter these trades whether they produce a barrel of oil or not. The producers are called hedgers and the non-producers are called speculators. If a company hedges more production than they have, they are partly hedging and partly speculating, but the commodities broker and counter-party really doesn't care. You rarely even know who the counter-party to your trade is.

If company X swapped 10,000 bbls in January on December '14 $80 contracts, but only produces 5,000 bbls, and Dec 14 settles at $60, they collect $20 x 10,000 bbls or $200,000.

Oil producers aren't typically speculators, so they rarely hedge more than they produce. In fact, if a producer has 70% of their production hedged, that's what we call fully hedged. The problem with the current downturn is there was a lot of backwardation in futures contracts for the past year. The front month was trading at $100/bbl, but if you wanted to swap 9 months out you could only get $88/bbl. Mentally, that's a hard position to take when oil is currently worth $100. Even a costless collar was $78-$98, so a lot of companies weren't hedging very far into the future either by time or by percentage of production.