Newfield Exploration (NYSE:NFX) has made some major changes over the last few years. The results of this effort have been impressive. However, it is still an exploration and production company, and that means there are ongoing risks that Newfield simply can't avoid.
Over the last five years, Newfield has sold roughly $2 billion worth of foreign and non-core assets to facilitate and fund its business shift. Essentially, it has winnowed down its portfolio to four key plays. That has allowed it to focus on improving performance, including increasing oil and natural gas liquids production to around 50% of the business mix. And overall production is expected to continue along at an impressive 28% growth rate through 2016.
That's great, no question about it, and it helps explain why the shares have moved up notably this year. However, the current success doesn't change the basic business model inherent to E&P companies.
Commodity price volatility
Like most drillers, Newfield hedges its oil and gas sales. At the end of the second quarter, it had oil hedges out to mid-2017 and gas hedges through 2015. That limits the impact of what have been historically volatile commodity prices. However, hedging has its downside.
Although it limits the damage a price drop will inflict, it also limits the upside potential from price increases. If oil or gas prices take off, Newfield's results would be left behind to some degree, which could lead to a stagnant share price, or worse.
However, the longer-term risk is what happens after prices change and hedges fall off. For example, if oil prices suffered a prolonged and material drop, Newfield would face a hedging cliff. As soon as its higher priced hedges rolled off, earnings would quickly fall. Don't overlook this key factor.
Drilling is uncertain
Another big thing to watch is the company's success at the drill bit. Although it has been doing a good job of increasing production and reducing costs, investors are increasingly aware of this. That means Newfield needs to keep putting up good numbers.
But drilling is inherently uncertain. For example, Royal Dutch Shell's (NYSE:RDS-B) projects and technology director, Matthias Bichsel, has noted that, "Not all fields are created equal." He was specifically speaking about shale gas plays, but the same thing is true of all energy drilling efforts. Some work, some don't.
Right now, Newfield's drilling programs are running at or above expected decline rates. If new drilling doesn't hold to these results, investors could sour on the shares. Which would make sense, because Newfield's prospects would be much less certain.
Is fracking good or bad for Newfield?
One of the big reasons behind the U.S. energy renaissance has been hydraulic fracturing, a process Newfield uses. Hydraulic fracturing involves pumping water, chemicals, and sand underground to free up the oil and gas trapped below. The U.S. energy industry loves the technique.
However, environmentalists pretty much hate the idea of shoving chemicals into the Earth. It has been blamed for such woes as wasting water, polluting underground water reserves, releasing dangerous pollutants into the air, and earthquakes. In fact, the practice has been banned in many parts of the world, including some domestic locations. So there is some regulatory uncertainty there.
At the end of the day, there's far more good news at Newfield than bad news. However, you can't simply ignore the ups and downs of an often-volatile industry because things are going well right now. Nor can you stop watching the developments in a key technology the company uses. Newfield is doing well right now and should continue to do so, but keep an eye on these issues since they could derail that progress.
Reuben Brewer has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.