As I anticipated in my forecast, XTO Energy (NYSE: XTO ) produced profits for pleased shareholders this quarter. The company beat its own production guidance, with gas and liquids output up 12% over the prior year. Along with strong pricing, particularly for natural gas, this output growth led to a 35% rise in adjusted earnings. This figure backs out one-time items such as last year's large gain on a distribution from Hugoton Royalty Trust (NYSE: HGT ) , a high-yielding company spin-off.
Part of the reason for the torrid production growth was the backlog in the Barnett Shale. Some infrastructure projects were delayed within this prolific unconventional gas play, which prevented a lot of wells from being completed. Completion is the last stage before a well can start pumping out the hydrocarbons. Once the infrastructure came online, so did a whole lot of wells. Barnett's output rose a massive 24% sequentially, a gain that's unlikely to repeat itself.
Lest you be concerned about XTO's exposure to recently weakening natural gas prices, there's actually a large hedging program in effect here. Hedging, in this case, means that the company caps its exposure to commodity price fluctuations, both to the upside and the downside. Management is comfortable with hedging one-half to two-thirds of its production.
This program doesn't just limit risk. It also "keeps an orderly shop," allowing the company to go about doing what it does best -- increasing production with minimal expense -- without having to worry too much about timing that level of production to the commodity cycle. This hedging program could certainly hold XTO's shares back in the event of a sharp rise in the natural gas price, but I find the reasoning here very sound.
Given the hedge program, I'm surprised to see XTO's shares dragged down with smaller E&Ps like Cimarex Energy (NYSE: XEC ) . XTO, which I believe is a low-risk operator, has actually fallen more than 9% in recent days. If this keeps up, I may count myself an XTO shareholder sooner than I would have anticipated.