Billion-Dollar Hedge Funds Aren't Done Making Money Yet. Here's How They're Doing It.

Source: Linn Energy Media Relations.

If you're an investor who thinks all of the great opportunities in America's energy boom have been taken, there are quite a few hedge funds that would disagree with you. According to data from Factset.com, hedge funds increased their holdings in energy companies by almost $6 billion in the fourth quarter of last year, the most of any other sector. Of that big uptick in buying, four companies -- Whiting Petroleum (NYSE: WLL  ) , Talisman Energy (NYSE: TLM  ) , Valero Energy (NYSE: VLO  ) , and Cameron International (NYSE: CAM  ) -- represented more than $3.3 billion of it. Let's look at these four companies and why hedge funds seem so fond of them.

Whiting Petroleum's rise in this group can be attributed almost exclusively to one hedge fund, Paulson & Co. In the fourth quarter, Paulson & Co. loaded up on more than $592 million worth of Whitings shares to bring his total investment to $640 million. Unlike its peers in the Bakken, Whiting flies a bit under the radar because it's not the top producer, but its total production of 94,800 barrels makes it one of the top three producers in the Bakken. It has also been one of the drivers of technological innovation for shale drilling. By using pre-perforated cemented liners and a fracking technique known as sliding sleeve fracturing, the company has seen average production rates at 30-, 60-, and 90-day intervals all 50% greater than the old plug-and-perf technique.

Not only will this open up new opportunities at many of Whiting's existing wells, but it will also make its newer shale ventures in the Niobrara shale in Colorado that much more attractive. Both it and Noble Energy -- which shares a large portion of Whiting's acreage -- have considerable positions in a part of the Niobrara that yields oil per spaced horizontal well almost double that of the Bakken. Combine these two elements and you get a top-flight American producer with lots of room to run.

Like Whiting, Talisman Energy is on this list because of one investor, Carl Ichan and Ichan Capital. In the fourth quarter of the year, Ichan Capital bought $811 million worth of shares in Talisman, making it one of his largest holdings. Like many of Ichan's other positions, he is looking to make some transformative changes to turn the prospects around for this fledgling oil and gas producer. Talisman has suffered greatly from trying to bite off more than it can chew, with oil and gas assets on six continents and not enough cash flow to fund the development of them all. Talisman CEO Hal Kvisle has done a commendable job of selling off about $3 billion in assets in 2013 to cover costs and plans to sell another $2 billion this year so it can develop some of its more promising assets like the Eagle Ford and Marcellus shale in the U.S. and some offshore blocks in Indonesia. 

In a recent analyst report from Berstein Research, Talisman is worth much more than its total enterprise value of $15.7 billion. To realize that potential, though, it will need to clean up its balance sheet and get capital spending under control, and that is exactly what Ichan will look to do now that he has installed two of his people on the board at Talisman. 

Valero is quite possibly the furthest from a turnaround story possible, and hedge fund managers are getting wise to this company that is firing on all cylinders. Viking Capital, Millennium Management, and Blue Mountain Capital were the three big buyers of Valero stock, combining to buy $737 million worth of shares. The hedge fund managers are likely looking at two elements that make Valero so attractive right now: increased access to Canadian crude and exports of refined products.

Valero refinery locations; refineries in yellow. (Source: Valero investor presentation)

While many investors may be fixated on the price spread between West Texas intermediate and Brent, the thing that they may be missing is that this does not affect Valero as much as others. A large amount of Valero's refining capacity is in the Gulf Coast, and most of those refineries are actually geared to run heavy oils like those from Venezuela and Saudi Arabia. With increased pipe and rail shipments of Canadian oil sands to the Gulf Coast, it will be able to drastically reduce its feedstock costs. The company has also been on the winning side of refined product exports over the past year. Valero is currently exporting more than 325,000 barrels per day of gasoline and diesel from the U.S. to premium markets such as Europe and South America. These two elements has led to some strong quarterly results and the attention of many hedge fund managers.

Of all the companies that saw major purchases this past quarter, Cameron International saw the most hedge fund money poured into it. Six major funds all made purchases in excess of $75 million, combining for a total investment of $1.1 billion. While the business has seen a large uptick in revenue and a building backlog of orders, a big catalyst for the company may actually come from one if its competitors: National Oilwell Varco (NYSE: NOV  ) .

National Oilwell Varco will be spinning off its distribution business into DistributionNOW. Why this matters for Cameron is that the new distribution business will sell more than just NOV parts and products, and it's likely that Cameron will be able to sell some of its equipment through this new distribution company. This will provide Cameron additional access to markets and countries around the globe. NOV has 1,250 locations across 62 nations, compared with Cameron's 300 or so. If Cameron can get some of its production capacity issues settled, the ability to use National Oilwell Varco's distribution network could mean very good things for the comapny. 

What a Fool believes
Not every hedge fund is going to get it right when it comes to buying and selling companies, but knowing what they are buying and the potential reasons for buying can be a valuable tool for individual investors to make their own investment decisions. Of the four energy companies hedge funds have selected this quarter, both Whiting and Valero give the most compelling cases for investment. They are both comapnies already on solid footing with room to run.

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