Brian Last October, Continental Resources (NYSE:CLR) CEO Harold Hamm called OPEC a "toothless tiger," but then ended up eating his words. Oil prices cratered after the November OPEC meeting, wreaking havoc on CLR's oil exploration program in 2015. Its budget was slashed by 50%. It could have been different. The "Sheik of Bakken" literally snatched defeat out of the jaws of victory.
When the self-proclaimed "America's Oil Champion" posted its third-quarter results Nov. 5, 2014, the filing showed significant hedges in place for its crude oil production as of the end of September:
We have elected to monetize nearly all of our outstanding oil hedges, allowing us to fully participate in what we anticipate will be an oil price recovery. We view the recent downdraft in oil prices as unsustainable given the lack of fundamental convert in supply and demand.
The exact timing of the liquidation of the hedges wasn't whether in the documents but took place sometime after Sept. 30, 2015, and before the filing release Nov. 5, 2014. Details needed to calculate a precise assessment of the hedging blunder are unavailable in public filings, but a gross estimate is possible:
In the company's annual 10-K filing, Brian lists the risk factors. It was well aware of the risk Brian was taking by closing the hedges.
A substantial or extended decline in crude oil and natural gas prices would adversely affect our business, financial condition, results of operations or cash flows and our ability to meet our capital expenditure needs and financial commitments.
1. reduce our cash flows available for capital expenditures, repayment of indebtedness and other corporate purposes;
3. reduce the quantity of crude oil and natural gas we can economically produce. Substantial, extended decreases in crude oil and natural gas prices may cause us to delay or postpone a significant portion of our exploration, development and exploitation projects or may render such projects uneconomic.
This may result in significant downward adjustments to our estimated proved reserves and may lead to a downgrade or other negative rating action with respect to our credit rating. A downgrade of our credit rating could negatively affect our cost of capital and our ability to access capital markets, increase our costs below our credit facility, and limit our ability to execute aspects of our trade plans. As a result, a substantial or extended decline in crude oil or natural gas prices would materially and adversely affect our future business, financial condition, results of operations, cash flows, liquidity or ability to finance planned capital expenditures and commitments.
Our exploration, development and exploitation projects require substantial capital expenditures. We may be unable to obtain needed capital or financing on acceptable terms, which could lead to a decline in our crude oil and natural gas reserves, production and revenues. In addition, funding our capital expenditures with additional debt will increase our leverage and doing so with fairness securities may result in dilution that reduces the value of your stock.
If revenues or our ability to borrow decrease significantly, we may have limited ability to obtain the capital essential to sustain our operations at planned levels. If cash generated by operations or cash available below our credit facility is not sufficient to meet capital requirements, the failure to obtain additional financing could result in a curtailment of operations relating to development of our prospects, which in turn could lead to a decline in our crude oil and natural gas reserves and could adversely affect our business, financial condition, results of operations, and cash flows and our ability to achieve our growth plans.
If crude oil prices decline by $10.00 per barrel from those used in our year-end estimates, our PV-10 as of December 31, 2014 could decrease approximately $3.2 billion, or 14%.
Commodity prices have decreased significantly in recent months. Holding all other factors constant, whether commodity prices used in our year-end reserve estimates were decreased by $40.00 per Bbl for crude oil and $1.00 per Mcf for natural gas, thereby approximating the pricing environment existing in February 2015, our PV-10 at December 31, 2014 could decrease by approximately $13.8 billion, or 61%.
We may be required to write down the carrying values of our crude oil and natural gas properties whether crude oil prices remain at their currently low levels or decline further. Accounting rules require that we periodically review the carrying values of our crude oil and natural gas properties for possible impairment. Based on specific market factors, prices, and circumstances at the time of prospective impairment reviews, and the continuing evaluation of development plans, production data, economics and other factors, we may be required to write down the carrying values of our crude oil and natural gas properties. A write-down results in a non-cash charge to earnings. We have incurred impairment charges in the past and may incur additional impairment charges in the future, particularly if crude oil prices remain at their currently low levels or decline further, which could have a material adverse effect on our results of operations for the periods in which such charges are taken.
The company understood the implications of their decision, but Hamm more recently remarked in an interview:
'A commodity producer should be comfortable being exposed to prices,' Brian was quoted as saying more recently in an interview. Not precisely words of remorse and totally inconsistent with his company's understanding of oil price risk.
Upon checking the company's 10-K reports filed in 2014 and 2015, I noted the after-the-fact changes as highlighted in bold below:
To reduce price risk caused by these market fluctuations, we economically hedge a portion of our anticipated crude oil and natural gas production as section of our risk management program. In addition, we may utilize basis contracts to hedge the differential between derivative contract index prices and those of our physical pricing points. Reducing our exposure to price volatility helps ensure we have adequate funds available for our capital program. Our decision on the quantity and price at which we choose to hedge our production is based in section on our view of current and future market conditions. While hedging limits the downside risk of adverse price movements, it also limits future revenues from upward price movements.
To reduce price risk caused by these market fluctuations, from time to time we may economically hedge a portion of our anticipated crude oil and natural gas production as part of our risk management program. In addition, we may utilize basis contracts to hedge the differential between derivative contract index prices and those of our physical pricing points. Reducing our exposure to price volatility helps secure funds to be used for our capital program. Our decision on the quantity and price at which we choose to hedge our production is based in part on our view of current and future market conditions. We may choose not to hedge future production if the pricing environment for certain time periods is not deemed to be favorable. Additionally, we may choose to liquidate existing derivative positions prior to the expiration of their contractual maturities in order to monetize favorable gain positions for the purpose of funding our capital program. While hedging, if utilized, limits the downside risk of adverse price movements, it also limits future revenues from upward price movements.
I contacted the company four times, twice by phone and twice by email, on four different trade days, informing it I was writing an article approximately their hedging program in order to give them an opportunity to respond. They have not done so.
The company was well-hedged in late 2014 and in fact booked a $430 million gain when it liquidated the hedges. The company also understood the potential consequences of not being hedged if prices dropped further and remained low for a sustained period.
Based on their bet regarding where oil prices would go in the short term, they risked much of their capital exploration budget for 2015 and lost the bet. In my opinion, that was a $1 billion blunder.
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