Last month Continental Resources, Inc. (NYSE:CLR) CEO Harold Hamm called OPEC a "toothless tiger." Now, he's backing up that comment by unloading his company's oil hedges in anticipation that OPEC won't engage in a price war with American producers. In Wednesday's earnings release, Hamm said:
We view the recent downdraft in oil prices as unsustainable given the lack of fundamental change in supply and demand. Accordingly, 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.
The move, which saw Continental Resources net a $433 million one-time gain, is a big bet that OPEC blinks and cuts oil production, sending oil prices rocketing higher.
Oil companies like Continental Resources hedge exposure to volatile oil prices in order to mitigate some of that volatility and lock in cash flow. Given the recent downdraft in oil prices, most of Continental Resources' peers have actually been bulking up on oil hedges just in case oil prices grow weaker. For example, Devon Energy Corp (NYSE:DVN) noted in its third-quarter press release that it's increasing its oil hedges:
With rapid growth in high-margin production, the company has taken measures to protect its future cash flow. For the fourth quarter of 2014, the company has entered into various swap-and-collar contracts to hedge approximately 60% of its expected oil production at an average floor price of $92 per barrel.
The company has also increased its oil hedges for next year, as 50% of its oil production is now protected. Meanwhile, Pioneer Natural Resources (NYSE:PXD) noted in its third-quarter earnings release that it now has protection for 85% of its production for the remainder of this year and all of next year. Clearly, these peers aren't as bullish on oil prices as Harold Hamm is.
Oil prices and OPEC
By unloading its hedges, Continental Resources is now virtually 100% exposed to both the upside and the downside of oil prices. However, Hamm doesn't seem worried about the exposure to the further downside in oil prices. He believes that despite Saudi Arabia saying it won't cut production, it really won't have a choice given that many members in OPEC need oil over $100 per barrel in order to balance their budgets.
In fact, several OPEC officials have said that a further fall in oil prices will lead to a production cut. The Wall Street Journal reported this week that $70 oil is likely the price that would trigger an output cut. The article quoted several OPEC officials who met informally this week ahead of the full OPEC meeting later this month. One official was quoted as saying, "At $70 a barrel, there will be panic in OPEC," while another noted that at $70 per barrel, OPEC would take action.
Some OPEC nations desperately need higher oil prices to make ends meet. Bloomberg reported this week that many OPEC members are feeling the pain of lower oil prices. Venezuela, for example, gets 96% of its earnings from oil and loses $700 million in revenue each time oil drops by a dollar. The country needs oil prices well over $100 per barrel just to balance its ballooning budget.
Meanwhile, Ecuador's economy is in trouble as well due to the fall in oil prices. With oil prices in the low $80s, the country's government would face a very large deficit of 5%-6% of GDP next year. Nigeria, likewise, needs very high oil prices to balance its budget. One of the impacts it has experienced is a steady drop in its foreign-exchange reserves. The list of struggling nations within OPEC goes on, as many in the cartel became very used to the lavish cash flows that came from $100 oil.
Hamm sees this as a sure sign that OPEC has no choice but to cut oil production in order to get the price of oil to go up. Because of this, he's more worried that Continental will miss the upside when oil prices head higher than he is about protecting his downside. It's a very bold bet that could either prove to be very lucrative or come back to bite him.