November 6, 2014 / 12:12 PM / in 3 years

Going out on a limb, North Dakota oil titan scraps hedges

WILLISTON N.D. (Reuters) - Harold Hamm, chief executive of Continental Resources Inc CLR.N, stunned a bearish crude market by scrapping all of the North Dakota energy producer’s oil hedges, betting that prices will recover soon after sinking 25 percent in recent months.

The Continental Resources office building is seen in downtown Oklahoma City, Oklahoma September 22, 2014. REUTERS/Steve Sisney

With the move, Hamm, who last month called OPEC a “toothless tiger,” appears to be heading into a price war with Saudi Arabia, the world’s biggest oil exporter, without any protection from a prolonged downturn that some analysts say is looming.

Saudi Arabia and 14 other OPEC members have shown no sign yet of moving to cut production, a step that would lift prices.

The conventional wisdom is that the country, frustrated by a global supply glut caused by soaring United States output, is prepared to let prices fall to squeeze U.S. shale oil producers out of the market.

But Hamm, striking a defiant tone, told investors Thursday the U.S. shale boom won’t end any time soon.

“We see OPEC worried about that and want to slow down what we’re doing,” he said.

Indeed, North Dakota considers OPEC its “chief competitor,” Lynn Helms, head of the state’s Department of Mineral Resources, said last month.

PREMATURE VICTORY

The sale of all its crude oil hedge positions from October through 2016 netted Continental a $433 million one-time gain for the current quarter. With the move, Continental is effectively declaring a premature victory over OPEC.

The company did not consult with credit-rating agencies before pulling contracts and board members are confident about the move, Hamm said.

“We believe the recent pullback in oil prices will ultimately prove to be beneficial to Continental,” he said, adding he believes prices will rebound to at least $85 per barrel in the near term.

Since they traded at more than $115 a barrel in mid-June, benchmark Brent crude futures LCOc1 have plunged to levels not seen since October 2010, closing near $83 a barrel on Wednesday.

Still, Hamm showed at least part of his hand, admitting he would return to hedging production if prices returned to $100 per barrel.

“That would be nice in the next few years,” he said.

Many energy experts said that when prices began falling in June, companies should have been carrying more hedging contracts that locked in high prices and protected them from low ones.

“It’s pretty unusual for a company to monetize all of its hedges. The fact that they’re going basically unhedged on oil suggests that they’re going to take on a bit more risk,” said Leo Mariani, an analyst at RBC Capital Markets.

SHORT-TERM FLUKE?

The rout in the price of oil has punished drillers like Continental, whose shares have plummeted more than 30 percent since June. Many analysts have forecast even lower crude prices.

Hedging protects commodity producers from sharp price drops, though it can also limit profits if prices soar. By exiting the hedges, Hamm is effectively betting that the steep drop in oil prices is a short-term fluke that’s bound to reverse course.

To be sure, going “naked” without hedges is not unprecedented. Majors such as Chevron Corp CVX.N and Exxon Mobil Corp XOM.N do little hedging on their own production.

And Continental did maintain its hedges on natural gas production, given the even-higher volatility in prices for that commodity.

Philip K. Verleger, president of consultancy PKVerleger LLC and a one-time adviser to President Jimmy Carter, said Continental’s decision on oil hedging may concern investors.

“My expectation is that Continental’s investors will rue this decision because it changes the firm’s business,” he said. “Hedging provides an assured cash flow. By dropping the hedges the firm is gambling that prices go up. If they go down, Continental will go bust.”

Shares of Continental were down more than 3 percent in afternoon trading on Thursday, a probable sign of Wall Street’s displeasure with the move.

SLOWER SPENDING

Yet, in a bit of a strategic hedge, Hamm slashed Continental’s 2015 capital spending budget by $600 million, saying he would not put more drilling rigs in the field while prices are low. Given that, Continental doesn’t expect its production to jump as much as previously forecast next year.

The company now expects a 2015 capital budget of $4.6 billion, down from a previous estimate of $5.2 billion.

Continental, the largest producer in North Dakota’s Bakken field, trimmed its estimate for output next year and now expects a 23-29 percent jump from 2014 levels. Hamm had previously forecast a 26-32 percent jump in 2015.

The company runs 22 drilling rigs in North Dakota, a number that will drop to 19 next year due to various factors, executives said.

Hamm, who founded the Oklahoma City-based company in 1967, is in the midst of a bitter divorce battle with his wife Sue Ann.

Since Hamm owns about 68 percent of the company, the divorce settlement holds vast implications. During much of August and September, the CEO spent most days in court for his divorce trial, which may result in one of the largest divorce judgments in U.S. history.

Reporting By Ernest Scheyder in Williston, and Jonathan Leff and Jessica Resnick-Ault in New York; Writing by Terry Wade and Ernest Scheyder; Editing by Tom Hogue and Bernadette Baum

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